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A For a number of years in our Tracker newsletters we have published relative strength ranking lists based upon a stock's or fund's internal strength as measured by Decision Point's proprietary PMO (Price Momentum Oscillator).

I have observed these lists over a long period of time, and my impression has been that the top stocks and funds do exceptionally well when the broad market is rising, and extremely poorly when the broad market is in decline; however, I wanted to construct a more objective way on measuring the performance of these top securities.

The idea occurred to me of constructing a "Top 5 Index". This is done by calculating the daily change of the Index as being the daily average percent change of the securities in the Top 5 list. Stocks/funds are tracked from the day after they enter the Top 5 list through the day they drop off the list.

The Top 5 (or 10) Indexes are unweighted, meaning each stock/fund in the list carries the same weight, so theoretically one could only replicate the performance of the list with real money by reallocating an equal amount to each security each day (and somehow avoid transaction fees in the process). To be more blunt, the Top 5 lists are a good place to look for securities that will out-perform the market, but it will be impossible for you to duplicate the Index. You could also lose a ton of money if you are long these top ranked securities during an extended market decline.

Our back testing was conducted over a bull market period when we would expect the strongest stocks and funds to out-perform the market. We also found that the top stocks and funds under-performed the market on down legs by about 25%.

Primary testing was performed on The Fidelity Select and ETF Tracker groups. Our group of 152 blue chip stocks is too large to test on MS Excel, however, we now have collected several years of data, which demonstrates that the 152 Blue Chip Top 10 delivers performance similar to the Top 5 Indexes. You should always open positions based on good chart patterns and manage the positions intelligently.

To begin, let's look at the Fidelity Select Top 5 Index. We have the longest period of historical data for this group. For comparison we began the Fidelity Select Top 5 Index on 12/4/92 at the same level as the S&P 500 Index (432.06). The test period ended 10/18/99 with the S&P 500 at 1254.13 (+190%) and the Fidelity Select Top 5 Index at 2007.84 (+365%). See chart below.

                                      SPX  Top 5   Annual  Annual
Index                From       To  % Chg  % Chg     Gain    Gain
---------------- -------- -------- ------ ------   ------  ------
Fidelity Top 5   12/04/92 10/18/99  +190%  +365%     +31%    +50%

Fidelity Top 5   12/12/97 10/18/99   +32%   +46%     +17%    +24%
ETF Top 5        12/12/97 10/18/99   +32%  +118%     +17%    +63%

Fidelity Top 5   07/17/98 10/08/98   -19%   -10%
ETF Top 5        07/17/98 10/08/98   -19%   -24%

Fidelity Top 5   10/08/98 07/16/99   +48%   +61%
ETF Top 5        10/08/98 07/16/99   +48%  +133%

Fidelity Top 5   12/31/98 10/18/99    +2%   +17%
ETF Top 5        12/31/98 10/18/99    +2%   +37%

Why do the top relative strength securities do so well? Why don't they decline as fast as they rise, resulting in the decliners cancelling out the advancers? The reason is that top performing securities don't have to reverse to the downside to drop off the Top 5 list. They may simply continue to advance at a slower rate, which causes them to drop in rank even though they are still moving higher in price. The result is that, during broad market advances, most of the top ranked securities will be trending higher in price, even though there is rotation on and off the list.

Why don't the highest ranked securities do better than the broad market during bear markets? I had thought that they would probably be the ones most likely to resist a decline. I think it has to do with the short duration of the 1998 Bear Market. I have designed the PMO to be responsive to short-term shifts in relative strength, but  top ranked securities often have PMO readings that are far above the securities that are lower in rank, so, while the PMO may be declining rapidly, it is likely that the PMO of other securities in the list are dropping as well and it can still take a long time for the top PMO's to get low enough to cause the security to drop out of the Top 5 list. In a bear market that extends over a period of a year or longer, performance of the Top 5 lists might be much better.

In conclusion I want to emphasize again that the top ranked stocks and funds are a good place to look for the best securities to buy during a bull market , but they could be the worst performers at the beginning of a bear market.

We provide daily charts of the Fidelity Select Top 5, ETF Top 5 Indexes (Samples below) in the Daily Chart menu reserved for subscribers. We no longer provide charts of the Rydex and ProFunds Top 5 Indexes because they have large numbers of leveraged bull and bear funds, which generate a lot of noise and cancel each other out.