NYSE McClellan Oscillator (MO)

In the previous article we discussed Advances & Declines, as well as the A/D line and A/D Ratio indicators that are derived from them. Today, we look at another breadth-based indicator - the NYSE McClellan Oscillator ($NYMO). It is derived from the same daily Net Advances (advances minus declines) on the NYSE. It was named after Sherman and Marion McClellan who invented it in the 1960's.

The McClellan Oscillator (MO) is a short to intermediate-term momentum breadth indicator, which simply means it is designed to determine the strength of a market trend. It is based on the concept that a strong up-trending or down-trending market is characterized by a large number of stocks advancing or declining moderately in a collective manner, rather than a small number of stocks making large gains or losses. It is based on the movements of an Exchange (New York Stock Exchange is the most followed) not on any one particular stock. It is calculated daily and attempts to anticipate positive and negative changes in the A/D statistics for market timing purposes.

19EMA and 39EMA of daily Advance-Decline Issues - Enlarge

In order to better identify the trend that is taking place in the daily breadth, we smooth the A/D data by using special type of calculation known as an exponential moving average (EMA). It works by weighting the most recent data more heavily, and older data progressively less. The amount of weight given to the more recent data is known as the smoothing constant. The numerical difference between the 19-day exponential moving average (EMA) of Net Advances less the 39-day EMA of Net Advances is basically the value of the McClellan Oscillator (MO).*

The NYSE Daily McClellan Oscillator (MO) - Enlarge

As a difference of two moving averages, this indicator oscillates above/below the zero line. When the 19-day EMA (shorter moving average) moves above the 39-day EMA (longer moving average), the oscillator crosses above its zero line signaling short term breadth momentum is strengthening and turning the corner. It signals that advances are gaining the upper hand. Conversely, when the 19-day EMA declines below the 39-day EMA, the Oscillator crosses below its zero line. It signals that declining issues are dominant and short term breadth momentum is weakening.

Are you lost? Don’t! It’s very easy. If I understood how to use the MO, trust me, anyone can. Let’s take it bit by bit.

First, what is an oscillator?

An oscillator is an indicator that fluctuates above and below a centerline or between set levels as its value changes over time. Oscillators can remain at extreme levels (overbought or oversold) for extended periods, but they cannot trend for a sustained period. More!

Second, what is exponential moving average EMA?

It’s a data series that is simply formed by computing the average (mean) price of a security over a specified number of periods usually using the closing price. For example: a 5-day simple moving average (SMA) is calculated by adding the closing prices for the last 5 days and dividing the total by 5.

10 + 9 + 11 + 15 + 15 = 60 / 5 = 12

The calculation is repeated for each new daily price on the chart. The averages are then joined to form a smooth curving line that we call the moving average line, which makes spotting trends far easier than the raw data. Continuing the example above, if the next sixth day closing price in the average is 15, then this new period would be added and the oldest day, which is 10, would be dropped. The new 5-day SMA then would be 13 instead of 12. In order to reduce the lag in SMA, technicians apply more weight to recent prices relative to older prices according to a calculated formula producing what is known as the exponential moving averages EMA. More!

Now, you know what an oscillator is and what is an EMA. Good start, don’t you think? For the calculation, you don't need to worry! It is automatically performed for you and presented as a chart that anyone can understand and use. You will not need to calculate anything and no math is required.

Back to the MO!

Now we got the calculation_^** behind us, all we have to do on our part is to know the symbol $NYMO to enter it in the chart's symbol box to get the plotted chart of this oscillator for any time-frame available we desire (see chart above). Make sure to choose the “Area” type instead of Candlesticks. See the previous two links for more details.

What are the benefits of the McClellan Oscillator?

As general guidelines (not hard rules guaranteed to result in profitable trading every time), the MO can offer us many types of structures for interpretation such as:

1. When the Oscillator is positive, it generally portrays money coming into the market; conversely, when it is negative, it reflects money leaving the market.

2. Moves below zero Line, render a Short-term SELL Signal while a Short-term BUY Signal results when it moves above its zero (flat) line.

3. A thrust above +50 is viewed as bullish for the stock market, while a thrust below -50 is viewed as bearish.

4. The MO fluctuates between an oversold territory (-100 and below) and overbought territory (+100 and above). When the Oscillator reaches these extreme readings, it can reflect an overbought or oversold condition._^***

5. The oscillator leads the index; so if it fails to confirm a new index high or low, the index may be forming a top or bottom. We can look for positive or negative divergences in the Oscillator. A series of rising troughs would denote strength, while a series of declining peaks weakness. Divergence provides a warning but should be combined with other signals and indicators to provide better entry or exit points.

Usually when the index is rallying but more issues are declining than advancing, it signals that the rally is narrow to small number of stocks that are making large gains while much of the market isn't participating, which characterizes a weakening bull market. Although the perception that the overall market is healthy based on prices, in reality it isn't based on breadth and participation. Conversely, when a bear market is still declining, but a smaller number of stocks are declining, an end to the bear market may be near.

Even though this breadth indicator is not perfect, its level can help determine overall market direction and underlying strength but its greater value lies in its longer-range version known as the McClellan Summation Index (SI), which I'll discuss in my next article.

To sum it up:

According to the MO, to give a strong buy signal, the Oscillator must cross first over zero. Then it must thrust (but not necessarily stays) over +50 to confirm the initial buy signal that we got when we crossed above zero.

For the strong sell signal, it’s the opposite. Let me give you an example from the chart above. The Oscillator thrust under zero on Jan. 12, 2009 giving the first sell signal but stayed above –50 until Feb. 13 (near a market top) where it thrust under –50 to the bearish zone confirming the sell signal. It was not able to come back above zero until March 11 and above +50 on March 13, 2009 to the confirmation bullish zone giving a strong buy signal.

Notice: Like MACD and other momentum oscillators, the McClellan Oscillators provide earlier signals. While earlier signals are desirable, they are also more prone to whipsaw (being wrong). I usually smooth the data by using 5 DMA to avoid sharp gyrations and one-day events but I don’t completely discredit a one time thrust under –50 or over +50 (see chart - dotted black line).

As of today and from the chart above we can see that:

While the NYSE AD Line is advancing steadily and making new highs, the MO is not. The NYSE AD Line moved straight up in July and then zigzagged higher in August. As the AD Line zigzagged, the McClellan Oscillator moved lower, crossed into negative territory, and even plunged below -50 which is considered short term bearish signal for the market. It reflects a more divided market. We have yet to see enough selling pressure to affirm medium-term bearish. If we crossed back above zero, chances will improve the bullish continuation of the rally but if we failed to cross over +50, chances more selling will continue before finding a bottom.

Click here for chart update as of Sep. 9, 2009.

Until next article and as always I wish you as much as you wish for yourselves and even more.

Please rate this article at the top of the page. Thanks!

GoodVibe
Mr. Lucky

Critique - Through a multi-part series about the MO, Michael Stokes believes that despite the fact that the MO is based on advancing and declining issues (rather than price like most indicators), the end result is more or less the same. Click here for great read.

Footnotes:

More about calculation - Reference 1.2.3

^*When calculating the MO, the ratio-adjusted index is often used for easier comparisons over long periods of time. The basic input for the ratio-adjusted version is no longer the daily advances minus declines.

Rather, you

1. Subtract declines from advances to get net advances.
2. Divide the result by the total of advances plus declines.
3. Calculate fast EMA1 (19 day) of what you receive from #2
4. Calculate slow EMA2 (39 day) of what you receive from #2
5. #3 result subtract from #4 result
6. Multiply #5 result by 1000 (for whole numbers instead of decimals).

McClellan Oscillator
=

{EMA1 of [(Advancing Issues - Declining Issues)/total Issues]
-
EMA2 of [(Advancing Issues - Declining Issues)/total issues]}
* 1000

(Note: The first time you begin to calculate an exponential average, you must calculate a simple moving average.)

^**The McClellan Oscillator daily value is calculated by getting a 39-day exponential moving average EMA (0.05 exponent) average and a 19-day exponential moving average (0.1 exponent) average. After calculating the two averages each day, we subtract the 39-day EMA of advances minus declines (5% Index) from the 19-day EMA of advances minus declines (10% Index).

Today's 10% Index - Today's 5% Index
=
Today's McClellan Oscillator

The following are the exact formulas (the "*" is the spreadsheet version of a multiplication sign):

5% Index: [(Today's Adv. - Decl. - Prior Day's 5% Index) * 0.05] + Prior Day's 5% Index = Today's 5% Index

10% Index: [(Today's Adv. - Decl. - Prior Day's 10% Index) * 0.10] + Prior Day's 10% Index = Today's 10% Index

One more change that applies to the Summation Index found here is that zero (0) is now considered neutral for the Summation Index, so you no longer begin with 1000 in your Summation Index calculation.

^***A "typical" MO pattern series consists of consecutive formation of a Complex Bottom, a Middle Spike, and a Buy Spike. Dropping below the zero line normally signals the beginning of a Complex Bottom formation, an extended period of oscillation below the zero line, which is the result of the negative breadth associated with corrections or consolidations. The typical Complex Bottom is a bowl-shaped series of oscillations below the Zero Line while the market is declining.

This is followed by a move well above zero, which begins the formation of the Middle Spike -- a stalactite between the move above zero and the move back below zero. The Middle Spike signals the beginning of an intermediate-term up move, but it is usually followed by another down move, possibly to lower lows. After the down leg of the Middle Spike has concluded, we can expect a Buy Spike, which as the name implies signals a new up trend in the market.

Buy Spikes are normally formed in oversold territory (-80 and below), but rising series of Buy Spikes is also a possibility. While this is a typical series of chart formations that will help us identify changes in market direction and determine current market status, unfortunately, they may not appear in the specified order . . . or at all. - Reference.