Ratio Indicator

🔍 What Is the Ratio Indicator?

The Ratio Indicator is a comparative analysis tool used in technical analysis to evaluate the relative strength or performance of one security, index, or asset against another. Instead of measuring absolute price movements, it focuses on relative performance over time. Traders and investors commonly use the Ratio Indicator to identify outperforming or underperforming assets within sectors, indexes, or pairs (e.g., comparing the price of one stock to a benchmark index or a competing stock).

The ratio is typically calculated by dividing the price of one asset (A) by another (B), and plotting the resulting values on a chart. This creates a ratio line, which rises when Asset A outperforms Asset B and falls when Asset A underperforms.

⚙️ How Does It Work?

The formula is straightforward:

This ratio is calculated over time and plotted on a line chart, showing the relative strength between the two assets. For example, if you compare Stock A to S&P 500, and the ratio line is trending upward, it means Stock A is outperforming the market.

The Ratio Indicator does not require any complex calculations or parameters—it simply tracks the relationship between two assets.

📖 How to Read the Ratio Indicator

Reading the Ratio Indicator is intuitive:

• 📈 Upward Slope: Asset A is outperforming Asset B. This could be due to Asset A rising faster, or Asset B falling more quickly.

• 📉 Downward Slope: Asset A is underperforming Asset B.

• ➖ Flat Line: Both assets are performing similarly.

By observing the ratio line, traders can spot emerging relative strength, sector rotation, or weakness.

Additionally, overlaying moving averages or trendlines on the ratio can help identify longer-term trends or reversals in performance.

⚙️ Best Settings for the Ratio Indicator

Since the Ratio Indicator is essentially a price ratio between two instruments, there are no settings to tweak in the basic calculation. However, for enhanced analysis, traders often:

• Apply moving averages (e.g., 20-day or 50-day MA) on the ratio line to smooth the trend.

• Use technical indicators like RSI or MACD on the ratio line to find overbought/oversold conditions in relative strength.

• Zoom in/out on the chart to identify longer-term vs. short-term trends.

🧠 How to Use the Ratio Indicator in a Strategy

The Ratio Indicator can be integrated into various strategies:

1. Relative Strength Trading

Use the ratio to identify stocks or sectors that are consistently outperforming the benchmark or other competitors. Traders can go long on strong assets and short on weak ones.

Example: If the ratio of Tech ETF / S&P 500 is rising, it signals tech is outperforming. A trader may allocate more capital to tech stocks.

2. Pair Trading

Compare two correlated assets (e.g., two stocks in the same industry). If the ratio deviates from historical norms, it may signal a trading opportunity.

Example: If Stock A and Stock B usually have a stable ratio but the line suddenly spikes, it may suggest one is over/undervalued relative to the other.

3. Sector Rotation

Monitor ratios of different sectors (e.g., Consumer Staples / Consumer Discretionary) to identify economic cycles and adjust positions accordingly.

4. Benchmark Comparison

Track how your portfolio or a particular asset is performing against a benchmark index or ETF using the ratio. Useful for portfolio managers.

⚠️ Common Mistakes When Using the Ratio Indicator

❌ Ignoring the underlying trends: A rising ratio doesn’t necessarily mean Asset A is rising—it could mean Asset B is falling faster.

❌ Comparing unrelated assets: Comparing two assets with no correlation or connection can lead to misleading results.

❌ Overinterpreting short-term noise: Ratios can fluctuate due to volatility. Always look for consistent trends and consider smoothing with moving averages.

❌ Not adjusting for corporate actions: Events like stock splits or dividends may distort ratio calculations.

🧠 Final thoughts

The Ratio Indicator is a simple yet powerful tool that helps traders and investors understand performance in context. Rather than just focusing on absolute price moves, it highlights how an asset is performing compared to others, which is crucial for making informed allocation decisions.

While it doesn’t generate traditional buy or sell signals like oscillators or trend-following indicators, it gives valuable insights for relative strength analysis, sector rotation, and pair trading.

When used wisely—especially in combination with other indicators—the Ratio Indicator becomes a strategic advantage in both trend-following and mean-reversion systems.