The McClellan Summation Index: The Mother of Market Timing Tools

03/30/2010 12:01 am EST

Focus: STRATEGIES

The McClellan Summation Index is an indicator that forecasts future market movements using the number of advancing and declining securities on the New York Stock Exchange (NYSE) opposed to being calculated on price change.

The McClellan Summation Index (MSI) is the cumulative sum of the daily McClellan oscillator figures. The McClellan oscillator (MO) takes the difference between two exponential moving averages (EMAs) of the daily NYSE advance-decline $NYAD) net values. The MO is the difference between the 19-day and the 39-day exponential moving averages (EMAs) of the daily net advance-decline figures. The MO is a market breadth indicator that helps us evaluate the money flow of the stock market. Its purpose is to help determine if money is entering or exiting the stock market, indicating whether overbought or oversold conditions exist. The McClellan Summation index is a version of the MO that is adapted for longer trends.

McClellan Summation Index is expressed as:

Oscillator = (19-day EMA of securities advancing - securities declining) - (39-day EMA of securities advancing - securities declining) + Previous day's McClellan Summation Index

Both the McClellan Oscillator and Summation Index are market breadth indicators. Market breadth simply refers to the measurement of the number of issues advancing versus the number of issues declining on a given day or by expressing that information using moving averages.

The bottom window of the graphic below shows the 19-day and 39-day EMAs of the NYSE Advance/Decline Issues ($NYAD). Notice when the 19-day EMA crossed above the 39-day EMA that the McClellan Oscillator moves above its zero line (see the middle window). In contrast, when the 19-day EMA moves below the 39-day EMA, the MO falls below the zero line.

chart
Click to Enlarge

In mid-February, the 19-day EMA crossed above the 39-day EMA of $NYAD, while simultaneously, the McClellan Oscillator moved above its zero line, marking the February lows. Then on March 24, 2010, the 19-day EMA crossed back below the 39-day EMA of the EMYA Advance/Decline Issues, causing the MO to fall back below zero. Two days later, on March 26, 2010, the MSI toppled below its five-day EMA, tipping traders off to a possible top.

The upper window showcases the McClellan Summation Index (MSI), which again is a longer-range version of the MO (Figure 1). It is used to spot major market turning points in the market, giving traders a longer-range view of market breadth. The Summation Index is a proxy that identifies whether money is flowing in or out of the market. Additionally, the MSI oscillates between readings of positive and negative territory with a zero line separating the two, which can help determine if a bull or bear market is present.

The MSI current assessment of market conditions is bearish in spite of the growing bullish optimism. Despite the MSI being in positive territory, it has crossed below its five-day EMA, which I use to confirm bullish and bearish trading signals. When the MSI flies above its five-day EMA, the stock market is usually advancing, and when it is riding below it, the market is more than likely correcting. The recent bearish conditions on the MSI hint that the market is likely in store for a correction. Using the five-day EMA of the MSI helps separate the good from the bad signals given from the MO. If a MO signal is legitimate, it will be usually be confirmed by the MSI moving above or below its five-day EMA a few days later. Using this signal helps prevent whipsaws.

The system isn’t perfect though, because it gave inconsistent signals back in November of 2009 when the NYSE was moving sideways. But ultimately, the market moved higher, which was validated by the Summation Index. Nevertheless, the MSI currently suggests that the market is overbought and that traders are taking money off the table.

By using the MSI, you will improve your trading skills by taking a lot of the guessing out of your investment decisions. You will get more accurate and predictable results of directional moves by using this trustworthy market breadth indicator.

By Ron Walker of TheChartPatternTrader.com

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