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McCLELLAN OSCILLATOR
Overview
The McClellan Oscillator is a market breadth indicator that is based on the smoothed
difference between the number of advancing and declining issues on the New York Stock
Exchange.
The McClellan Oscillator was developed by Sherman and Marian McClellan. Extensive
coverage of the oscillator is provided in their book
Patterns for Profit.
Interpretation
Indicators that use advancing and declining issues to determine the amount of participation
in the movement of the stock market are called "breadth" indicators. A healthy bull market
is accompanied by a large number of stocks making moderate upward advances in price. A
weakening bull market is characterized by a small number of stocks making large advances in
price, giving the false appearance that all is well. This type of divergence often signals
an end to the bull market. A similar interpretation applies to market bottoms, where the
market index continues to decline while fewer stocks are declining.
The McClellan Oscillator is one of the most popular breadth indicators (another popular
breadth indicator is the Advance/Decline Line). Buy signals
are typically generated when the McClellan Oscillator falls into the oversold area of -70
to -100 and then turns up. Sell signals are generated when the oscillator rises into the
overbought area of +70 to +100 and then turns down.
If the oscillator goes beyond these areas (i.e., rises above +100 or falls below -100),
it is a sign of an extremely overbought or oversold condition. These extreme readings are
usually a sign of a continuation of the current trend.
For example, if the oscillator falls to -90 and turns up, a buy signal is generated.
However, if the oscillator falls below -100, the market will probably trend lower during
the next two or three weeks. You should postpone buying until the oscillator makes a
series of rising bottoms or the market regains strength.
Example
The following chart illustrates the five "trading zones" of the McClellan
Oscillator (i.e., above +100, between +70 and +100, between +70 and -70, between -70 and
-100, and below -100).
This next chart shows the McClellan Oscillator and the Dow Industrials.
I drew "buy"
arrows when the Oscillator rose above -70
and "sell" arrows when the Oscillator fell below +70. This indicator does an excellent job
of timing entry and exit points.
Calculation
The McClellan Oscillator is the difference between 10% (approximately 19-day) and 5%
(approximately 39-day) exponential moving averages of advancing minus declining issues.
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