The rally did not last long and the NYSE Composite made new lows on June 4. The McClellan oscillator just dropped to -123 and did not make new lows. Therefore, a bullish divergence, line b, was formed. The SMA of the P/C formed lower highs, line d, which confirmed the action in the McClellan oscillator. By June 6, a bottom had been confirmed as I noted at the time in Rally Potential That Bears Don’t Expect.
I realize that many of you may not have the capability to plot the McClellan oscillator with the P/C ratio. As I mentioned in an earlier article, you can monitor the McClellan oscillator on StockCharts.com by following this link.
In an earlier trading lesson, A Treasure Trove of Technical Tools, I focused on the site www.indexindicators.com, and they also have a wide range of Put/Call data. This includes the CBOE Total Put/Call, CBOE Index Put/Call, and CBOE Equity Put/Call.
The chart above covers all of 2013 and below the chart of the S&P 500 is a chart of a five-day SMA of the Total Put/Call ratio. I use these signals to time the Spyder Trust (SPY) and the above chart can be found here.
In late December of 2012 as stocks dropped sharply in reaction to concerns about the fiscal cliff, the ratio spiked to one standard deviation above the mean (point 1). The technical reading at that time indicated this was a buying opportunity.
As the Spyder Trust (SPY) was making its low in February at $147.23, the five-day SMA of the P/C SMA came very close to the two standard deviation level at 1.09 (point 2) with a daily high in the P/C of 1.17.
A similar sharp increase in put volume, as measured by the SMA of the P/C, occurred in the middle of April, as noted by point 3. The decline from the May high to the June low was more severe as the Spyder Trust (SPY) dropped 6.4%. The MA of the P/C formed twin peaks (point 4) at 1.15, and on a single day, the P/C came very close to 1.40.
The lowest reading, so far in 2013, came in the first week of September (point 5) as the P/C SMA had a low of 0.77 with a single day reading of 0.67. The Spyder Trust (SPY) had another correction from the September 20 high to the October 9 lows as it was down 5.2%. The SMA of the P/C reached the 1.00 level at the October low (point 6).
At the start of December, the P/C dropped below 0.80, and it is now trying to turn up as the stock market is correcting. It is well below levels normally associated with market bottoms and the McClellan oscillator has been quite weak since the middle of November. Both should be monitored as we head into the end of the year.
I hope these examples will have demonstrated why combining these two quite different technical indicators can be a valuable tool. They are especially accurate in identifying short-term market bottoms but are not as good as the A/D line in identifying market peaks. Both are quite good in confirming market corrections. Veteran option expert Larry McMillan, has developed several computer-generated trading systems from the Put/Call data, which you may find interesting.
In terms of the stock market’s major trend, the NYSE Advance/Decline, is still the best tool and the readings from it should be combined with the McClellan oscillator and Put/Call ratio. The A/D line will also help tell you whether a market correction is just a pullback within a major trend or whether a more significant correction is likely.