THE MCCLELLAN OSCILLATOR SUMMATION INDEX INDICATES WHETHER MONEY IS FLOWING INTO OR OUT OF THE MARKET

Last week I wrote about the McClellan Oscillator and how it provided an important market-timing tool. Whereas most overbought/oversold indicators, such as stochastics, are based on the price of an index, such as the S&P 500, the McClellan Oscillator is based on advancing vs. declining issues. (An advancing issue is one that closes higher in a given trading day by at least a penny. Meanwhile, a declining issue is one that closes down by the same amount.) The advantage of this tool is that it gives a reading independent of price. In this manner, it provides another way of judging whether the market is overbought or oversold.

A reading on the McClellan Oscillator of plus or minus 100 signals the market, as judged by the broad NYSE Composite Index, is "officially" overbought or oversold. (The McClellan Oscillator can also be computed on other indices, such as the Nasdaq.) In practice, however, it is best to judge the oscillator in accordance with its own support and resistance levels. In the recent decline, -200, not -100, has been the most commonly hit extreme reading.

The Summation Index is an Intermediate-term market-timing tool. It is computed by adding or subtracting the daily McClellan Oscillator from a running total. On Thursday, April 1st, for instance, the Summation Index was at 2346.47. On Friday, the final reading on the McClellan Oscillator was 106.98. That amount could then be added to Thursday's reading to give us the current Summation Index, which is 2453.45.

The Summation Index is a proxy that tells the swing trader whether money is flowing into or out of the market. When the Summation Index is in a strong uptrend, it indicates that the bulls are stronger than the bears. In a downtrend, it communicates just the opposite. Note also the spacing of the dots. When the dots are very close together, they indicate that the daily McClellan Oscillator readings are relatively flat. When they widen, these readings are more extreme and point to a very strong trend.

In a bull market, the Summation Index will typically vary between 0 and 2000, with a reading of 1000 being considered neutral. Readings above 2000, such as we have now, are indicative of very powerful bull market advances. Readings between 1000 and 0 point to the bear being ready to go on the prowl. And finally, -iIf the reading reaches -1000, then a reversal in the bear market may be nearby.

As the chart below shows, the current Summation Index peaked in late January, ahead of a peak in the NYSE. (The McClellan Oscillator and Summation Index are typically aligned with the NYSE Composite, since that is the broadest index of that exchange.) The NYSE reached the same level in price in late February and early March, but with much lower readings on the Summation Index. This much lower high was divergent and made the price action suspect at that time. 

With the rally that began on March 25th, the Summation Index has crossed the important 2000 level and is again heading higher. It is very close to penetrating a downtrend line that can be drawn on the Index. 

I am now watching for the Summation Index to peak, as it should provide another opportunity to go short. If the Summation Index breaks 2000 when it next falls, then it will likely contain an important clue about the longevity of this bull market.

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