Traders have access to hundreds, if not thousands, of technical indicators designed to help predict price movements and enhance risk-adjusted returns. Market breadth indicators are designed to measure the difference between stocks that close higher (advancers) and those that close lower (decliners), with the running cumulative total known as the daily advance-decline line or AD Line for short.
The AD Line can prove to be quite choppy, especially in shorter time frames, so the McClellan Oscillator was developed to smooth the data using exponential moving averages (“EMAs”). The AD Line is shown in Figure 1.
Be sure to read Everything You Need to Know About Market Breadth Indicators
EMAs weight recent data more heavily than older data, which is progressively weighted progressively less using what’s known as a smoothing constant to determine the slope of the gradient.
In this article, we’ll take a look at the McClellan Oscillator, how to use the indicator, some examples of the indicator in action, and some things to keep in mind.
What is the McClellan Oscillator?
The McClellan Oscillator, seen in Figure 2, was developed by Sherman and Marian McClellan as a breadth indicator that functions similar to the popular moving average convergence-divergence (“MACD”) indicator does for stock prices. A detailed overview of the indicator and its usage can be found in their book “Patterns for Profit,” available from McClellan Financial Publications.
The oscillator is calculated by subtracting 39-day exponential moving average (“EMA”) of net advances from the 19-day EMA of net advances. Using the oscillator value and the two input values, traders can use the indicator in the same was as the MACD indicator by watching for crossovers and divergences. In fact, many traders consider the McClellan Oscillator to be “the MACD for the AD Line”.
Some charting providers, like StockCharts, also adjust the “oscillator”;http://traderhq.com/stochastic-oscillator-ultimate-guide/ value by using the net advances as a percentage of advances plus declines in lieu of simply net advances. The ratio enables market technicians to compare the indicator’s levels over time, which is important given the growing number of stocks included in popular market indexes like the NYSE and NASDAQ over time.
Adding up the daily values of the McClellan Oscillator yields an indicator known as the McClellan Summation Index. Many traders use the same ratio-adjustment techniques mentioned above in order to create what’s known as the Ratio Adjusted Summation Index (“RASI”), which provides further insights into market movements and ultimately helps traders develop more accurate opinions.
Using the McClellan Oscillator
The McClellan Oscillator is a market breadth indicator that’s used in the same way as the MACD indicator is used for stock prices. If the oscillator is in positive territory, then the 19-day EMA is above the 29-day EMA signaling that advancers have the upper hand over decliners. If the oscillator is in negative territory, then the opposite is occurring and decliners have the upper hand over advancers.
Similar to the MACD indicator, positive readings bode well for bulls, negative readings bode well for bears, divergences with the stock price can be a sign of reversal, and thrusts can signal the start of a long-term move higher or lower. The only difference is that market breadth is being measured rather than stock price, which means that it’s more of a sign of market psychology than MACD.
The McClellan Oscillator also has a number of drawbacks as a momentum indicator like MACD. In particular, the indicator’s readings can prove quite volatile and choppy at times, requiring traders to wait for confirmation before acting on the information. As always, the indicator is best used in conjunction with other technical indicators in order to form a complete opinion on price movement.
When using the Ratio Adjusted Summation Index, the market’s neutral level is the 1,000 point level, with readings largely staying between 0 and 2,000. The index offers many different types of insight – similar to the oscillator, which means that traders should keep much more in mind than just the numerical value. For instance, divergences and convergences can again play a key role.
Indicator in Action
The McClellan Oscillator is used analyzing major indexes rather than individual stocks given that it’s a market breadth indicator, although it can provide useful insights into where individual securities within an index may be headed. When analyzing these overall markets, the indicator is best used in combination with other technical indicators in order to confirm price trends.
In Figure 3, the ratio-adjusted NYSE McClellan Oscillator consistently made new highs before breaking the trend to the downside in July 2014, despite improvements in the underlying index. At the same time, the McClellan Ratio Adjusted Summation Index also broke down in a divergence from the underlying NYSE Composite index, suggesting that the composite index may be due for a near-term correction.
Traders should note that these indicators come as the NYSE Composite Index itself continues to trade near its highs, which means that the oscillator and summation index can often provide leading indicator-like predictions. These predictions should be confirmed with candlestick analysis or other price or volume types of analysis to weed out any false breakouts or breakdowns and confirm a reversal.
The Bottom Line
The McClellan Oscillator is a market breadth indicator that uses two net advances EMAs to calculate an oscillator value. Market technicians use the McClellan Oscillator in very much the same way that they use the MACD indicator when it comes to stock prices. Like many momentum indicators, traders should be aware of the choppy nature of the McClellan Oscillator and seek confirmations. The McClellan Summation Index provides an additional less choppy version of the oscillator in order to help traders better identify trends.
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