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Shares in Aviva took a dive yesterday after the company cut its dividend. While the news took many by surprise there was always a potential risk the company would cut the dividend. Let’s not forget that a few weeks ago RSA Insurance cut its dividend prompting a sell-off in the share price. A simple observation on the chart would have warned investors to stay away prior to the results.
The Relative strength (comparative) compares two securities to show how they are performing relative to each other. Using this indicator to compare Aviva’s performance to the FTSE 100, you can see that the relative strength line at the bottom of the chart was rising until the end of 2012 highlighting strength in the stock. However, that quickly reversed and was lower by the end of February – sending technical warning signs of underlying weakness and a potential change in trend.
The relative strength indicator is widely used in the stock market to compare a stock to an index. A security’s price change (Aviva) is compared to another security’s price change (FTSE 100). When the stock outperformed the index, the relative strength line rises (indicating strength) and when the stock underperformed the index, the line falls (indicating weakness).
The general rule is that stocks like Aviva that have a high beta should outperform the FTSE 100 when the stock market rallies (rising line).
In early February the price dipped below the 50-day MA and a bounce followed, as you would expect. However, this time the stock failed to rally above the moving average on two occasions. By the end of February the price was still below the 50-day moving average and the relative strength line was still declining. That was the reason why I was not keen to go long Aviva at the end of February.
The basic rule here is that if after two months a high beta stock can’t keep up with the general market (FTSE 100) and the general market is rising, it is suspicious. This simple observation was a clear warning not to go long prior to the results.
Thierry Laduguie is Market Strategist at www.bettertrader.co.uk
