Relative Rotation Graph

strategies Charts

Profiting From Rotation RRG can help you spot important shifts in market leadership by charting the relative strength of sectors or securities. By Paul Ciana, cmt

Most hedge funds, mutual funds and

asset managers measure their performance against a benchmark. It may be the Standard & Poor’s 500, Merrill Lynch Commodity Index eXtra or Barclays Capital Aggregate index or some other broad group of securities. If managers underperform benchmarks, their bosses generally won’t be pleased. Nor will their investors, who may withdraw money and move it elsewhere. So, knowing which groups of securities are

starting to under- or outperform your benchmark is an important part of staying ahead. To help do that, you can use the Relative Rotation Graph (RRG) function to analyze shifts in the leadership in your universe. Created by Julius de Kempenaer, RRG is contributed to the Bloomberg Professional service by his Gibraltar-based company, RRG Ltd. Type RRG to use the function. The default view displays the 10 Global Industry Classification Standard sectors of the S&P 500 compared with the index during a 12-week period. The scatter plot displayed in RRG is

built around two centered axes, creating four sections. These quadrants are defined as “leading,” “weakening,” “lagging” and “improving.” In essence, RRG normalizes several series of data so you can compare multiple securities or sectors that have varying levels of momentum and performance in one graph. Type RRG for the Relative Rotation Graph function. RRG’s scatter plot is divided into quadrants. Sector Rotation

An RRG chart shows decreasing investor interest in the S&P 500’s previously leading groups: consumer staples, technology and utilities.

1 1 4 bloomberg 114 b l o o m b e r gmarkets m a r k e t s March Decem 2012 ber 2010

underperform with decreasing momentum. (A short sale is a bet that a security’s price will drop.) According to de Analyzing assets Click on the arrow to the right of Kempenaer’s contribuSource and select Equity Index tion in New Frontiers in and enter IT30 in the NAME Technical Analyfield for an index of Italian stocks. sis: Effective Tools outperformer A chart of Italian stocks and Strategies for versus the Dow shows Trading and InTenaris rotated into vesting (Bloomthe “leading” quadrant in December. berg Press, 2011), his backtesting suggests that to maximize returns, picking the best investments is actually less important than avoiding the worst. One timely way to use RRG is to generate ideas for investing in financial markets that are in turmoil. Take ­Italy, for example, where stocks were buffeted by the euro-zone debt crisis in 2011. To compare the stocks in the Dow Jones Italy Titans 30 Index against the Dow Jones Industrial Average, type RRG again. Click on the arrow to the right of Source and select Equity Index. In the A chart shows Tenaris shares nearing multiple resistance levels in December after gaining NAME field, enter IT30. Tab in to the BASE field 57 percent. A break through those levels could propel the stock back to its January 2011 high. and enter INDU, click on Dow Jones Industrial Average in the list of matches and press . In RRG, the x-axis represents the JdK RS-Ratio, As you can see above, Tenaris SA, the world’s a proprietary measure of relative strength. If a data largest producer of seamless steel pipes used in point falls on the right side of 100 (in the “leading” the oil industry, had rotated from lagging to leador “weakening” quadrants), the security or sector ing as of December. Another interesting stock was is outperforming its benchmark. When it falls to Atlantia SpA, Italy’s biggest toll-road operator. the left side of 100 (in the “lagging” or “improving” In Milan trading, shares of Luxembourgquadrants), it’s underperforming. based Tenaris rose 57 percent to 14.18 euros on Dec. 29 from their low on Oct. 4. The shares The Y-axis is JdK RS -Momentum, a traded through their 50-day moving average as proprietary measure of the rate of change in the well as through the 38.2 percent and 50 percent RS-Ratio line. If a data point falls above 100 (in the retracement levels from the stock’s January 2011 “improving” or “leading” quadrants), its relative high. For much of December, the stock was litperformance is increasing in momentum. If a tle changed as price neared multiple resistance data point falls below 100 (in the “weakening” or levels, including a downward-sloping trend line, “lagging” quadrants), its performance earlier highs in December, the 200-day is decreasing in momentum. moving average and the 61.8 percent TIP BOX To make good relative returns, retracement. A break through those an asset manager could invest in or levels could propel the stock back to its Type RRGR overweight the sectors that are conJanuary 2011 high of €18.76. for more information sistently outperforming and have inabout Relative Paul Ciana, CMT, is an equities application creasing momentum. They could sell Rotation Graph. specialist at Bloomberg in New York.­ [email protected] short, underweight or avoid those that

March 2012 bloomberg markets 115