TRADING

A popular market breadth indicator, the McClellan oscillator is one of the tools that MoneyShow’s Tom Aspray has come to rely on over the years, and here he explains how he uses it, along with some formation examples.

The debate over whether it is possible to time the stock market has been going on for years and will likely continue into the foreseeable future. One of the difficulties in assessing the merits of market timing is that some of the analysis that goes into the determination is subjective rather than objective. This can make the testing of a methodology quite difficult.

Another key factor is the time frame that one is trying to predict. In other words, are you looking three months out? Six months? Years? Of course, the most difficult are the short-term forecasts as to whether the stock market is going to be up or down the next week.

Occasionally, you can make these with some degree of confidence but often only just after significant turning points when a top or bottom has been determined technically.

One of the key tools that I use to determine the intermediate- or long-term outlook is the weekly, as well as the daily, Advance/Decline lines. I have written about their application extensively in the past (One Indicator Stock Traders Must Follow), and they play an important role in my daily and weekly analysis.

Tracking whether the NYSE Advance/Decline is moving with prices or diverging from them has been a valuable tool in determining bull and bear markets. Trying to determine whether a correction will last several weeks or several months is more difficult.

One indicator that I have found often to be very useful in identifying the end of market corrections is the McClellan oscillator developed by Sherman and Marian McClellan in 1969. Their son Tom McCellan has continued their analysis of the markets and is an excellent technician, who covers a wide range of markets. I have had the pleasure of knowing this “pure technical family” for many years  and they provide a wealth of data, including daily readings of the market internals on their site.

In today’s Trading Lesson, I am going to share some examples of how I use the McClellan oscillator. My methods are likely to differ from Tom’s or that of other analysts. As I have repeatedly pointed out, a technical tool is only really valuable to another trader or investor if they study it enough to become convinced that it works. Only then will you be able to use it in real time.

The McClellan oscillator can be thought of as a momentum indicator of the A/D line as it looks at the difference between a 19-period and 39-period moving average of the net advances. Since the number of stocks traded has expanded so much in the past 20 years, percentage values are now used instead of the raw number of advancing or declining stocks.

I have been following the McClellan Oscillator since the 1980s and want to share with you some of the formations that I have found the most valuable, as well as instances where I rely on other measures of the market internals.

chart
Click to Enlarge

This chart of the NYSE Composite covers the period from January 2003 through June 2003. The McClellan oscillator (OSC) is plotted below the bar chart, and the dashed black line notes the zero line, while the dashed red line is drawn at -150.

Multiple positive or negative divergences often provide the strongest signals, and this is a classic example. The McClellan oscillator (OSC) had an initial low at -234 on January 27 (point 1) as the NYSE Composite closed below its daily starc- band.

NEXT PAGE: Examples of OSC Formations