One among a broad variety of market indicators, the McClellan oscillator tracks the market breadth of the New York Stock Exchange issues. Analysts construct a daily breadth by subtracting the number of stocks that closed at lower prices than the preceding day, or declines, from the number of stocks that advanced in price relative to the preceding day, or advances. In order to interpret trends properly from the daily breadth data, traders average the running cumulative total of daily breadth values over both 19- and 39-day periods, exponentially weighting the recent values more heavily. The McClellan oscillator value is the difference between the short-term, 19-day exponential moving average (EMA) and the intermediate-term, 39-day EMA of the daily breadth values. Analysts us the McClellan oscillator to quantify the flow of money into and out of the market and identify an oversold or overbought market.
P.N. Haurlan was the first to use exponential moving averages to analyze stock prices in the 1960s. In using exponential moving averages, the newest information produces the largest impact on the average, while the old data produces less impact on the average. A smoothing constant is the progressive percentage by which new information influences the oscillator value relative to the old data. The 19-day EMA utilizes a 10 percent smoothing constant, while the 39-day average employs a 5 percent smoothing constant. By emphasizing the fresh data, the McClellan oscillator reflects market momentum.
The McClellan oscillator formula subtracts the 39-day EMA from the 19-day EMA of the difference between the advances and the declines, so a positive McClellan oscillator value portrays a bullish market with lots of money flowing into it. Conversely, a negative value indicates a bearish market with money flowing out. When a few surging stocks are driving up prices, making the market appear bullish, the declining stocks decrease the EMAs and reduce the McClellan oscillator, which accurately identifies a weakening of the bull market. In general, a rising series of peaks and troughs in the oscillator values indicates a positive outlook to an analyst, while a declining trend of troughs and peaks predicts a market downtrend.
Investors may also use the McClellan oscillator to determine when to make an entry into the market or get out of a position. If the oscillator gets up to the positive 70 to 100 range, the market is overbought. When it declines from this range back into the range from zero to 70, the investor should consider selling the stock. If the McClellan oscillator value dips to the minus 70 to 100 range, the market has become oversold. An increase in the indicator from that point back up to the zero to minus 70 range may send a signal for the investor to buy.