Section 10:
McClellan Oscillator and Overbought and Oversold Readings
The McClellan Oscillator is market breadth indicator that is derived from the number of advancing and declining issues. It’s not as simple as the advance/decline line.
The McClellan Oscillator subtracts advancing issues from declining issues, and smoothes this number with a 19-day and 39-day exponential moving average. The oscillator then subtracts the 39-day exponential moving average from the 19-day to give its value. Ranges of the oscillators generally fall between -100 to +100.
The McClellan Oscillator is available on several broad market averages. For the sake of consistency, we like to apply the indicator to the NYSE Composite ($NYMO). It reveals a different picture than the advance/decline line, even though we apply both to the NYSE Composite.
McClellan Oscillator Scoring
The McClellan Oscillator gets a score of +1 if the value of the indicator is greater than zero and rising. (See Figure 10.13)
Figure 10.13
The McClellan Oscillator gets a score of 0 if the value of the indicator is less than zero and falling. (See Figure 10.14)
Figure 10.14
McClellan Oscillator Overbought and Oversold Signals
The McClellan Oscillator can be extremely effective when trading bullish and bearish reversal patterns. The indicator reveals oversold and overbought conditions similar to other oscillators such as Stochastics. These overbought and oversold indicators are not incorporated in the Market Situation scoring system for the sake of simplicity. Nevertheless, they are good signals to watch for when trading reversal price patterns.
Readings between +50 and +70 signal overbought market conditions in which bearish reversal patterns have a higher probability of succeeding. (See Figure 10.15)
Figure 10.15
Readings between -70 and -100 signal oversold market conditions in which bullish reversal patterns have a higher probability of succeeding. (See Figure 10.16)
Figure 10.16