By: Chris Rowe — September 10, 2019
Would you like to pick better entry points for your trades? Better exits?
I have just the thing for you.
The McClellan Oscillator, developed by Sherman and Marian McClellan, is a market breadth indicator primarily used for short and intermediate-term trading.
You don’t hear much talk about this one, but it’s very accurate.
It is based on the smoothed difference between the number of advancing and declining issues on the NYSE.
Let me explain...
How is the difference “smoothed”?
The oscillator is formed by subtracting the 39-day exponential moving average from the 19-day exponential moving average of net advances (that is the difference between advances and declines).
(Click any image to enlarge)
Recall that an advance/decline line tracks the net difference between advancing and declining issues on any given major index.
(For more on advances and declines see "How to Be the First to Spot Changing Trends" here.)
Recall also that, unlike the simple moving average, the exponential moving average (EMA) works by weighting the most recent data more heavily, and the older data progressively less heavily.
This indicator basically shows whether the momentum of the advance/decline line is increasing or decreasing.
The McClellan Oscillator is an excellent indicator for timing entry and exit points, and I’m surprised that it’s not offered for free just about anywhere.
The divergence between the two MAs is negative when the number is declining during a bull market. It signals a weakening in a bull market that is likely to at least correct.
The divergence is positive when this number is advancing in a bear market. It signals a strengthening of the market that might soon bring the bear market to an end.
In the historical chart, below, you can see that leading up to the sharp correction in February of 2007, the McClellan Oscillator made lower tops and lower lows, indicating a weakening bull market.
You can also see a channel of lower tops and lower lows leading up to the next correction in June.
Crossings above the zero line are positive signals that suggest money is coming into the market. They happen when the shorter term (19-day) moving average crosses above the longer term (39-day) moving average. These are considered short to intermediate-term buy signals.
Crossings below the zero line are negative signals that suggest money is coming out of the market, and are considered short to intermediate-term sell signals.
Readings above +70 up to +100 range from overbought to extremely overbought. Conversely, readings below-70 to-100 range from oversold to extremely oversold.
Traders anticipate a downward price correction when the McClellan Oscillator is above 70 and look for a relief rally when the McClellan Oscillator is below -70.
Buy signals are given when the Oscillator first drops into the oversold area of -70 to - 100 and then turns up. Sell signals are given when it first rises into the overbought area of +70 to +100 and then turns down.
Don’t make the mistake of taking extreme readings alone as buy or sell signals. They only become buy or sell signals when the oscillator reverses from extreme levels.
You can see below that the McClellan Oscillator also signaled a market reversal when it dipped below -70 and turned back up.
Just as the A/D ratio remains constant over time as the number of issues that are traded on the particular index change, the “ratio adjusted” McClellan Oscillator calculation remains constant for the same reason.
This ratio is calculated by subtracting declines from advances, and dividing the result by the total of advances plus declines.
So if you're looking to master the art of timing entrances and exits... this indicator is just right.
See you soon,