The McClellan Oscillator is a market “breadth” indicator based on the smoothed difference between the number of advancing and declining issues on the New York Stock Exchange. The oscillator is a popular market breadth indicator that can be used for market timing for short-term traders.
This indicator can give traders a true sense of what is happening under the surface in the stock market, making it one of the most popular breadth indicators. The McClellan Oscillator was developed by Sherman and Marian McClellan. Extensive coverage of the oscillator is provided in their book “Patterns for Profit.”
The McClellan Oscillator measures breadth. Breadth refers to the fraction of stocks that are participating in an up or down move in the market. For example, if a large number of stocks are participating in a down move, then we can interpret this as being bearish. It is said that the downward move has significant breadth.
If, on the other hand, only a small number of stocks are participating in the down move in the market, then we can interpret this as being bullish. A healthy market is one where the predominant price move is accompanied by a large number of stocks following suit. A weak or weakening market is characterized by a small number of stocks participating in the predominant price move, giving the false appearance that all is well. This type of divergence often signals an end to the predominant move.
The McClellan Oscillator is the difference between 10% (approximately 19-day) and 5% (approximately 39-day) exponential moving averages (EMA) of advancing minus declining issues. It is plotted against the movements of a particular exchange.
Ratio Adjusted Net Advances (RANA) = (Advances – Declines) / (Advances + Declines)
McClellan Oscillator = 19-day EMA of RANA – 39-day EMA of RANA
19-day EMA = (Current Day RANA – Prior Day EMA) * .10 + Prior Day EMA)
39-day EMA = (Current Day RANA – Prior Day EMA) * .05 + Prior Day EMA)
Let’s look at a chart of the SPX with the McClellan Oscillator below it (see “Weak hands,” below). Here, we might interpret the recent bullish price move as unsustainable. It is taking place in conjunction with a flat to falling McClellan Oscillator. This implies that a relatively small number of stocks are propping up the market.
The McClellan Oscillator can be used to time trades via overbought/oversold levels, breadth thrusts and divergences.
With respect to overbought and oversold levels, the McClellan Oscillator generates the buy and sell signals in the following ways:
- A buy is signalled when the oscillator hits the oversold area, -70 to -100, followed by a turn back up.
- A sell signal occurs if the oscillator rises into an overbought area of +70 to +100 and then subsequently turns down.
If the oscillator goes beyond these areas (that is, 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.
As seen in “Time to buy” (above), the S&P 500 went into the oversold zone and turned up, signaling a buy order be placed once the McClellan Oscillator turns back into the overbought zone.
In “Time to sell” (below), we can see that the S&P 500 went into an overbought zone and then turned down, signaling a sell that should be bought once the McClellan Oscillator turns back into oversold zone.
A breadth thrust occurs when the McClellan Oscillator surges from deep negative readings to strong positive readings. Typically, the indicator will move from below -50 and exceed +50 for a +100 point turnaround, or thrust. A breadth thrust signals a surge in bullish breadth that can lead to an extended advance and formation of a short-term bottom. Not all breadth thrusts foreshadow extended advances, but most important lows are marked by a sharp surge in breadth.
The chart “Breadth trade” (below) shows the German DAX with the McClellan Oscillator during the October 2014 bottom. Notice how the McClellan Oscillator surged more than 150 points. This surge reflected strong buying pressure that marked an important low. Think of it as a rocket on lift off. A strong surge is needed to solidify a low and escape the gravity of selling pressure. Also notice that the DAX continued higher until December 2014.
Bullish (positive) and bearish (negative) divergence in the McClellan Oscillator can foreshadow reversals in the underlying index.
First, a divergence should be confirmed with a strong supporting price move. A bullish divergence is confirmed with a strong move into positive price territory. A bearish divergence is confirmed with a strong move into negative price territory. Second, divergences should be sharp. The difference between the reaction highs or lows should be noticeable, not negligible. Do note that there will be many divergences and most will not result in reversals or extended moves.
The chart “Divergent behavior” (below) shows the Nifty 50 Index and McClellan Oscillator with a sharp bearish divergence in April 2015. Even though the Nifty moved to a new high in April 2015, the McClellan Oscillator formed a sharply lower high. The subsequent move into negative territory in April reflected a significant increase in selling pressure.
Pros & Cons
The McClellan Oscillator measures the momentum of the advance/decline line. As a momentum oscillator, it is prone to the pitfalls of other momentum oscillators. Bearish and bullish divergences can produce some great signals, but these signals are certainly not fail-proof. The same is true for breadth thrusts and crosses into negative or positive territory. The McClellan Oscillator is a rather volatile indicator that produces many potential signals. Signals should be confirmed or refuted with other technical indicators and chart analysis.