As investors, it’s important to recognize that not all areas of the market move in the same direction at the same time. While some segments, such as QQQ, may lead, others, like VXUS, may lag. Relative strength trading is a strategy we incorporate to help identify and invest in the areas of the market showing the strongest momentum.

At Stonehearth Capital Management (SCM), we use quantitative data from Ned Davis Research (NDR) to guide these decisions. This disciplined, rules-based approach allows us to rotate into strong positions and step away from weaker ones, removing emotion and bias from portfolio decisions. In this article, we’ll explain what Relative Strength (RS) is, why it matters, and how we apply it in client portfolios.

What is Relative Strength?

Markets are constantly shifting, and leadership rarely stays the same for long. Relative strength helps us stay aligned with these changes, offering three key benefits:

1. Disciplined Trend Capture

Momentum often persists. By systematically identifying these trends, RS allows us to participate in leadership while keeping emotions on the sidelines.

2. Global Diversification with Tactical Precision

RS spans multiple geographies and asset classes. This creates broad exposure while allowing us to concentrate capital where strength is most evident. Leadership often rotates across regions and sectors, and RS helps us respond objectively.

3. Adaptability to Investor Profiles

The strategy can be tailored. Our aggressive model holds the top four ETFs, offering higher exposure, while our moderate model only invests in the top two ETFs for less exposure, allowing us to adjust for investors risk tolerance.

Strategy Framework

At its core, this strategy is built on a rules-based momentum model that ranks a curated universe of ETF’s based on their price performance across multiple timeframes. The goal is to capture intermediate-term trends while remaining responsive to short-term shifts.

Timeframe Weighting:

1-Year Performance: Captures long-term trend strength.
6-Month Performance: Reflects medium-term momentum.
3-Month Performance: Adds sensitivity to recent market dynamics.

Weighting Bias: The 3-month period receives the highest weight, ensuring the strategy reacts quickly to emerging reversals or accelerations.

ETF Universe:

The strategy evaluates a diversified set of ETFs representing key asset classes and geographies:

Asset Class - ETF - Description

U.S. Equities - QQQ - Nasdaq 100
International Equities - SCZ - Developed ex-US Small Cap
Emerging Markets - IEMG - Broad EM exposure
Latin America - ILF - Regional equity exposure
Commodities - GLD - Gold
Commodities - DJP - Broad commodity basket
Real Assets - VNQ - U.S. REITs

Allocation Rules

Selection: Buy the top 2 or 4 ranked ETFs depending on the investor’s risk tolerance.

Rebalancing: Monthly review and re-ranking ensure the portfolio remains aligned with prevailing trends.
Capital Preservation: If all ETFs exhibit negative momentum scores, the strategy shifts to short-term bonds, avoiding exposure to declining asset classes.

Strengths and Weaknesses

Strengths:

Embraces real-time market trends using data, not emotion.
Provides an objective, disciplined framework for allocating capital.
Supported by research, with the potential to enhance risk adjusted returns.

Weaknesses:

Momentum can reverse suddenly, especially during sharp market shifts.

What This Means for Clients

Relative strength is a proven, research-based strategy that aligns your portfolio with the strongest market trends, without chasing short-lived narratives. At SCM, we tactically rotate among top-performing ETFs, adapting to your risk profile, capturing opportunities, and managing risks. This structured approach complements traditional asset allocation frameworks by combining trend-following discipline, global opportunity, and built-in downside awareness.

Disclosure: Past performance is not indicative of future results.

Relative Strength Trading