RELATED TOPICS --> | Introduction to McClellan Indicators | The McClellan Divergence Archives |
                               | *NEW* The McClellan Diffusion Index - works it all out for you! |


This instructional note provides a quick and basic overview of how to interpret and use the McClellan Oscillator and Summation Index. It is by no means an exhaustive narration, but just something to get you started with this wonderful breadth indicator as a serious investment tool.

You can get updated high-resolution McClellan charts from the JBAR Report and it appears in The Weekly JSE Pulse with analyst narration (both these resources are premium content for subscribers only). The charts as they normally appear are below:


This shows the McClellan Oscillator (MCOS) and the Summation Index (MCSI). The Summation index for the day is the previous day value plus today's MCOS reading. If MCOS is on zero, then the MCSI remains unchanged (moves sideways). If MCOS is -1 then the MCSI moves down by 1 from the previous day.

The McClellan Oscillator (MCOS)
The MCOS is the 19-day Exponential Moving Average (EMA) subtract the 38 day EMA of the daily NET ADVANCES (number of shares that went up in price less number of shares that declined in price). It is a very short term and rapid oscillator and if it is above zero it generally depicts money moving into the JSE (sellers are in control). If it is in negative territory then money is flowing out the JSE (buyers are in control). For the last 12 years its daily values have fluctuated between -10 and +10 extreme readings on the JSE.



If MCOS bounces along zero line fluctuating between positive and negative territory, the market is undecided and buyers and sellers are struggling for control (such as is occurring at the right of both charts above). A trend gets established when the MCOS forms complex structures above or below the zero line (8 or more readings). Complex structures imply coming strength from the side of the zero line they are formed. So a complex structure building above zero is a bullish signal.

When the McClellan Oscillator reaches an extreme high or low level, it indicates an extended condition for the market. In this respect, it is like many other overbought/oversold indicators, and like the others, an extended McClellan Oscillator reading is no guarantee that the extended market condition has to end right away. Extended readings on the McClellan Oscillator offer us some additional insights
when interpreted properly. First of all, deeply negative readings (below -8) tend to indicate conclusion of a down move, whereas extremely high readings (above +8) tend to show initiation of a strong new up move.

The MCOS reached over +7 15 times in the last 12 years and 10 of these occasions marked beginnings of big market moves up. It reached -7 34 times in the last 12 years with 21 of these occasions marking ends of down moves. At PowerStocks, we use these two values to mark our extended conditions for the oscillator.

When the Oscillator’s movements diverge from JSE index price action, it can signal an impending change in direction for prices. This is where it helps to understand that the Oscillator serves as an accelerometer for the market breadth statistics. A rocket that is fired into the sky will undergo a deceleration before it reverses direction and starts to fall back to earth, and the same behaviour is usually true for share prices. Also, a deeply negative Oscillator reading which comes along after a long period of quiet is a harbinger of more trouble to come.

A congestion occurs when the Oscillator fluctuates by very small increments over several days. One or two days of small changes is not enough, it has to be a sustained period. The Oscillator value area where a congestion occurs is called a “congestion zone”, and they usually form above the zero line. We seldom see them form at extended negative values. The basic rule to remember is that a congestion zone is something to signal time to get out the market.

The McClellan Summation Index (MCSI)
When the McClellan's were first working with the McClellan Oscillator, it occurred to them that the “area under the curve” was an additional important feature of this indicator. To calculate the undulating amount of this area, they added each day’s value of the Oscillator to a running total of all previous Oscillator values and in the process they created the Summation Index. This indicator changes each day by the value of the Oscillator, and protracted conditions of either a positive or negative Oscillator result in an extended value for the Summation Index.

The MCSI shows longer term market trends. When it is pointing up, demand is outstripping supply. When it is flat then buyers and sellers are struggling for control. When it is pointing down, supply exceeds demand (selling pressure is rising). The MCSI has ranged between +150 and -225 over the last 12 years as shown below.



MCSI is very good at signalling entry trades from deeply oversold conditions (when it is less than minus 75 as shown by the green line). When MCSI turns up for the first time from deeply oversold conditions you can be sure we have reached a turning point as this signal has very few false turns. MCSI has plumbed depths of below minus 75 some 16 times in the last 12 years and 9 of these occasions market major bottoms, 4 occasions minor bottoms, 1 occasion a sideways move and 2 occasions were caught in a bear trap in the 1997 and 2008 corrections. This makes the MCSI minus 75 line a terrific oversold indicator to trigger a BUY signal. When MCSI gets below minus 75 we wait for it to stop declining and make a turn upwards (when its MCOS swings from negative to positive territory) and then we have our BUY signal. Think of that - you have roughly one signal coming along every 9 months on average with a historical accuracy of 81.25%. Now who could ask for odds better than that?

Similarly it is an excellent indicator of market peaks (deeply overbought) but in this instance the actual value of the MCSI is less important than the size of its retracement. When it turns down from any point by more than 50 it is generally time to exit your short term trades. You can see the last big MCSI downturn NEARLY triggered a SwissClock DEFCON-1 SELL signal when it dropped from 50 to 10 on the chart at the very top of this page. The shorter your trade horizon the lower you make this threshold. If you are in on a warrants trade or other geared TOP40 instrument then you should exit the minute MCSI swings down (ie the minute the MCOS registers a negative reading.)

SwissClock trades according to the two broad rules (overbought/oversold) discussed above but of course we have our own proprietary mechanisms to eliminate false turns taken from time to time by the MCSI that lead to premature BUY and SELL signals.

The MCSI is also a good signal for beginnings of new bull markets. If, from a deeply oversold position, the MCSI manages to swing up by 175 points or more relatively uninterrupted into positive territory then this is usually a good sign on the commencement of a new bull market. If the recovery fails to trace 200 points into positive territory then the rebound is normally short lived and the bear market is not done yet. By this definition the recovery from the great 2008 crash rose the MCSI from a low of -131 to +49.5 (a rise of 180 points) before retracing and so technically we are in a bull market.

On a final note for the MCSI, it is interesting to note that international research has shown that very few bad things have happened on the US markets over the last 100 years when the MCSI is above zero. So if the PowerStocks MCSI is below zero and pointing down, we DO NOT want to be doing anything on the JSE except sitting on the sidelines! Using this approach you would have exited the JSE on January 2008, some 4 months before the big crash commenced on 20th May 2008!

DIVERGENCES
When the MCSI diverges from the JSE then that is usually a sign of bad things to come for the JSE. This occurs when the MCSI is moving on a downward slope and the JSE is flat or still moving in an upward trend. What this tells us is that the rise on the JSE is being accompanied by advances in fewer and fewer shares and that the market is weakening. We have catalogued 20 occurrences of this type of divergence on the JSE and each and every time a correction followed shortly afterwards. Our subscribers have access to this catalogue of divergences in the "McClellan Divergence Archives". Detecting and measuring divergence visually with McClellan can be challenging and we have developed a Disparity Index specifically to do this in its purest mathematical form. The McClellan Disparity Index is very useful for short term traders and anyone interested in advanced McClellan interpretation and we have written a HOW-TO for this technique here : "Using the Disparity Indices to detect and measure divergence "

TREND-LINING

You can apply simple trend-lining to MCOS and MCSI. From the chart above we can see that MCSI is posting higher highs and higher lows - the sign of a healthy bull run. The left chart has a short term support trend line for MCSI and the right chart a longer term one. We're a little worried about it dropping below its long term trend and so the idea is to watch for any trend weakness in the short term trend. According to international research, very few bad things happen to the market when MCSI is above zero. When MCSI is posting lower highs and lower lowers its a sign of bad things to come. You do not want to be in the JSE when MCSI is below zero and pointing down!

We have applied some of our trendlines to MCOS. Since this is a much more rapid indicator trendlines are short and we often create many of them to depict various possible trend scenarios that may exist depending on the changing conditions. If you look at the chart above you can see the sellers are gradually taking control over the last 20 days shown. The MCOS trendline is normally broken before the corresponding JSE trendline is broken and so this is a good predictor tool.

We have developed a unique tool called the McClellan Diffusion Index that takes all the components and relationships from the MCOS and MCSI and works out exactly how much you should allocate to the stock market depending on the risks inherent therein. Its available on the last link at bottom of this page.


RELATED TOPICS --> |Introduction to McClellan | McClellan Divergence Archive |
                               | *NEW* The McClellan Diffusion Index - works it all out for you! |
 
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