Relative Strength Alert: Results boost the London Stock Exchange (LON:LSE) share price

Shares in the London Stock Exchange (LON:LSE) rose sharply this week on positive earnings news, but the question now is whether that momentum will continue.

Finding stocks that can break-out and move higher on news updates is a tactic used by some of the world’s most successful traders. But it’s not a black-box strategy…

Indeed, knowing the factors that drive relative strength in share prices can help you find profitable momentum trades, too. I’m going to use London Stock Exchange (LON:LSE) as an example of how this can work.

How has the London Stock Exchange (LON:LSE) share price performed?

London Stock Exchange is a balanced, large cap in the Financial & Commodity Market Operators industry and it has a market cap of £16,166m.

Over the past year, the London Stock Exchange share price has risen by 18.1%, which sounds pretty good.

But it’s important to put this in context and look at the market trend. After all, in a rising market where prices are up across the board, that gain might not be as remarkable as it seems.

As it turns out, the FTSE All-Share index actually fell over the past year, which means that stock prices fell on average over that period. So London Stock Exchange has actually done better than it seems. Its shares have a 1-year relative strength of 19.0%.

Read on to find out what the evidence shows may happen next...

Why relative strength really matters

Relative strength is a crucial tool in the armoury of technical traders and investors. It’s an instant measure of how a stock has performed in comparison with a benchmark.

And while there are no certainties about which way a stock will move next, research shows that price trends often persist.

Studies by Narasimhan Jegadeesh and Sheridan Titman, who are leading experts on momentum, show that stocks with the strongest price strength tend to keep up the pace for anywhere up to one year.

But what causes this?

The answer is that investor behaviour plays a big role. Academics point to two key drivers:

• Under-reaction - prices are slow to move up because investors are hesitant to bid prices higher in stocks that have already been on a strong run.

• Delayed over-reaction - investors chasing rising prices attract the attention of other investors, who follow them into those trades, pushing prices higher and higher.

So the answer is that momentum in stocks with strong relative strength is at least partly caused by a virtuous circle of human emotion. Investors have to constantly re-price these improving shares in their own minds. 

It won’t always happen - and it might take some time - but when momentum takes over, it can push prices higher and higher.

What does this mean for potential investors?

London Stock Exchange is currently among the stocks with the strongest six-month and one-year relative price strength in the market. But momentum on its own is no guarantee of future returns. 

To get a better idea about whether this momentum will continue, it's worth doing some investigation yourself. Indeed, we've identified some areas of concern with London Stock Exchange that you can find out about here.