Stock Market McClellan Indicator

Investing Online - Stock Market for Beginners - The McClellan Oscillator

What is the McClellan Oscillator?

The McClellan Oscillator indicator is used in technical analysis by stock market analysts, technical analysts and chartists. It is a "market breadth indicator" overlaid onto stock market charts which indicates the rate of money entering or leaving the market thus indicating when there is an overbought or oversold condition. It was devised back in 1969 by Sherman and Marian McClellan, and is calculated using the exponential moving average (EMA) of the "daily ordinal difference of advancing issues" (stocks which have risen in value) from "declining issues" (stocks which have fallen) over periods of 19 and 39 trading days. The formula used to plot the Oscillator is:

Oscillator = (19-day EMA of Advances minus Declines) - (39-day EMA of Advances minus Declines)

Each day, there are stocks that close higher (advances) and stocks that close lower (declines). The gap between these advance/decline numbers is referred to as the daily breadth. The cumulative total is referred to as the Daily Advance-Decline Line.

This number is important because it correlates closely with stock market movements and gives another way of quantifying market movements.

When a bull market comes to an end for example, there is the possibility that a small number of stocks will make significant gains which will propel the index higher, but in fact there are a lot more decliners than advancers. This indicates that the market is starting to turn.

The converse is true at the end of a bear market. A few stocks may take the index down although a lot of stocks are in fact rising. This can indicate that the trend is changing.

If the McClellan Oscillator is in the area of -70 to -100 indicating an oversold situation and then turns up a buy signal is generated. Sell signals are generated when the oscillator rises to +70 to +100, indicating an overbought situation, and then turns down.

If the oscillator goes beyond these zones (i.e. above +100 or below -100), this indicates that the market is extremely overbought or oversold. These extreme readings are, however, contrary to expectations, usually a sign that the trend in place will continue.

For example - the oscillator falls to -90 and turns up, thus generating a buy signal. If however, the oscillator falls below -100, the market will probably continue to fall over the next 2 to 3 weeks. Buying should be delayed until the oscillator forms a series of rising bottoms or the market regains strength.

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