McClellan Oscillator and Summation Index: Trading Strategy and Backtest Analysis

Today, there are so many indicators used in technical analysis, but only a few are really valuable to retail investors and traders. These indicators are not just used for technical analysis of stock prices but are also used to get an idea of the sentiment in the equity market, helping you determine the number of equities closing higher relative to those closing lower in a particular index or stock market. The McClellan Oscillator and Summation Index are good examples of such tools.

The McClellan Oscillator is a market breadth indicator that is based on the difference between the advancing and declining stocks on an exchange, such as the Nasdaq Exchange, while the  McClellan Summation Index is a market breadth indicator that is a cumulative index of the McClellan Oscillator. In other words, the McClellan Summation Index is a running total of the McClellan Oscillator values.

Related reading: –Technical analysis indicators

In this post, we will discuss the essential things you should know about the McClellan Oscillator and Summation Index.We end the article by backtesting a McClellan trading strategy.

Here are the things we will cover (a backtest at the end of the article):

What is the Nasdaq McClellan oscillator?

The McClellan Oscillator is a market breadth indicator that is based on the difference between the advancing and declining stocks. The indicator can be applied to any equity market. When applied to the Nasdaq market, we refer to it as the Nasdaq McClellan Oscillator. Financial analysts use it to monitor the equilibrium between rising and falling stocks on the Nasdaq exchange, which is dominated by tech stocks.

The indicator uses data from the stocks listed on the Nasdaq Exchange which are published in financial journals. The number of equities that closed higher or lower, commonly known as advances and declines, is noted in these periodicals. Those numbers are used to calculate the difference between the advances and declines, referred to as the daily market breadth, which is used to calculate the McClellan oscillator.

Once the daily breadth has been calculated at the end of the day, the data are smoothed using an exponential moving average (EMA). The EMA gives more weight to more recent data and less weight to older data in reverse sequence. This quantity is known as the smoothing constant. Most analysts use 19-period and 39-period EMA in calculating the oscillator. The value of the McClellan Oscillator corresponds to the difference in numbers between these two EMAs.

What is the Nasdaq McClellan Summation Index?

The McClellan Summation Index is the long-term version of the McClellan oscillator, which indicates market breadth based on stock gains and losses. The index is a running total of the McClellan oscillator.

The McClellan Summation Index was created by Sherman and Marian McClellan for tracking long-term trends and reversals. Although it is called a summation index, it is actually an oscillator that fluctuates above and below the zero line, and as such, signals can be derived from bullish/bearish divergences, directional movement, and centerline crossovers. A moving average may also be applied to identify upturns and downturns.

What does the McClellan summation index measure?

The McClellan Summation Index is utilized in technical analysis to determine bullish or bearish bias and the trend’s strength. It offers a way of assessing the sentiment of the market by checking whether the market is predominantly going up or down. Analysts see it as a different way of assessing the state of the market rather than checking the price movement of the composite index, such as the Nasdaq composite index.

Since the Summation Index is a direct derivative of the McClellan oscillator, it rises when the McClellan oscillator is positive and falls when the McClellan oscillator is negative. Thus, extended positive numbers in the McClellan Oscillator cause the Summation Index to trend higher. Conversely, extended negative readings cause the Summation Index to trend lower.

However, given its cumulative nature, the Summation Index is a slower version of the McClellan Oscillator — the index crosses the zero line fewer times, forms divergences less often, and produces fewer signals in general. In other words, while the McClellan Oscillator can be used for short-term and medium-term timing, the Summation Index is generally used for medium-term and long-term timing.

There are three basic signals:

1. The Summation Index generally favors the bulls when positive and the bears when negative.
2. It gives bullish and bearish divergences, which analysts can use to anticipate reversals.
3. It can show directional movement, which can be used to define a bullish or bearish bias.

What does the McClellan Oscillator measure?

The McClellan Oscillator can be used to analyze different aspects of the market, but most analysts focus on three key areas:

1. How money flows into the market: The oscillator can be used to monitor money entering and exiting the market. When the McClellan Oscillator is positive, it indicates more money is entering the market than the amount leaving it, and when it is negative, it shows more money is leaving the market than the amount going in. A rising McClellan Oscillator indicates that stocks are being purchased. A falling McClellan Oscillator suggests that stocks are being sold off.
2. Overbought/oversold market condition: The McClellan Oscillator can indicate when the entire market seems overbought or oversold. This occurs when the McClellan Oscillator begins to give extreme readings.
3. A reversal in market trend: The McClellan Oscillator, whether positive or negative, reflects the current trend in the index. When the McClellan Oscillator shifts from positive to negative or negative to positive, it indicates that the trend is about to reverse. When stock prices and the McClellan Oscillator diverge, it indicates that the current trend is weak. For example, when the McClellan Oscillator rises while the index falls, it indicates that the current trend may soon reverse as stocks begin to be purchased. Similarly, when stock prices rise while the McClellan Oscillator falls, it indicates that prices are about to fall. A breadth thrust occurs when the McClellan Oscillator moves 100 points or more, either positive or negative.

Of course, just because these are the main ones doesn’t mean they’re all one can do with the McClellan oscillator. In reality, the McClellan oscillator can exhibit a wide range of significant shifts. It can also be used to determine the strength of an index’s trend by tracking divergence or confirmation.

Overall, the McClellan Oscillator measures the stock market’s health and assesses the strength or weakness of its current trends. Retail investors and traders can use the McClellan Oscillator.

Fortunately, using the McClellan Oscillator is simple. The most common method is simply observing the indicator’s color and direction of movement. If the McClellan Oscillator is red and very low, it indicates that the selloff in the market might be nearing its climax, so a buying opportunity may be imminent — a sign that the market is oversold. Of course, investors should remember to wait until the McClellan Oscillator turns green and begins to rise higher before making a purchase. When looking for sell signals, the inverse is true. When the stock enters the overbought territory, the McClellan Oscillator turns red and begins to fall.

You can combine the indicator with other indicators to confirm its findings and make specific decisions on individual stocks.

Does the McClellan oscillator work?

Yes, pundits say it does work when used the right way. The McClellan Oscillator differs from your usual technical trading indicators which you use to analyze individual stocks. It is a sentiment indicator, so it helps you to get a feel of the entire market movement. You use it to know what investors generally think of the market, but it cannot help you to make decisions about individual stocks.

In other words, if you are trading individual stocks, you can use it to get the sentiment in the market (for example, if the market is bullish or bearish) and then use other indicators to decide if a stock is worth buying and when to buy it. When used this way, the McClellan oscillator works very well.

In addition to using it to get a feel of the general market, you can use it to trade broad market index ETFs, such as the SPY. In this case, it can be used to make an educated guess about where the index, and by extension, its ETF, might go in the future. It also works very well when used this way. It’s a long way from looking at past and present share prices and making an educated guess about where the market might go in the future — it’s also taking into account things like the cumulative running total of daily breadth to make its signals.

The McClellan Oscillator performs so well in short and intermediate-term trading. This is because the McClellan Oscillator prioritizes recent data and gives less and less weight to older data as time passes. So, it shows the short-term momentum, making it useful for traders looking for the best entry and exit points in index ETFs. It’s also worth noting that the McClellan Oscillator outperforms other indicators in validating positive or negative trends and assessing the strength of an index trend through divergence or confirmation of the said trend.

How is the McClellan indicator calculated, and what is the formula?

The McClellan Oscillator can be calculated using one of two formulas. To begin, there is the original formula.  Then there’s the modified formula, which considers changes in the number of stocks listed. The adjusted formula allows for a more accurate comparison of values over time.

The original formulas for calculating the McClellan Oscillator are as follows:

• McClellan Oscillator: (19-day EMA of Advances − Declines) — (39-day EMA of Advances − Declines)
• 19-day EMA: (Current Day Advances x 0.10) + Prior Day EMA
• 39-day EMA: (Current Day Advances − Declines) x 0.05 + Prior Day EMA

The formulas for the adjusted McClellan Oscillator are as follows:

• Net Advances Adjusted (ANA): (Advances — Declines) ÷ (Advances + Declines)
• McClellan Oscillator Adjusted: (19-day EMA of ANA) ÷ (39-day EMA of ANA)
• 19-day EMA adjusted: (Current Day ANA — Prior Day EMA) x 0.10 + Prior Day EMA
• 39-day EMA adjusted: (Current Day ANA — Prior Day EMA) x 0.10 + Prior Day EMA

Applying the McClellan formula

Now that we’ve established these formulas let’s look at how to apply them. First, track the Advances — Declines on your preferred stock exchange (Nasdaq, for example) for 19 and 39 days. You can keep track of these in a spreadsheet or any other way that works best for you.

After that, take the values and enter them into the “Previous Day EMA” fields in the 19- and 39-day EMA formulas and use them to compute the 19- and 39-day EMAs and the McClellan Oscillator value.

Who invented the McClellan oscillator and Summation Index?

The McClellan Oscillator and Summation Index were developed by Sherman McClellan and his mathematician wife Marian. They created the indicators in 1969, and it took their combined talents to do the work then — a period when computers were unavailable and when charts had to be drawn by hand.

Sherman brought these indicators to the public during guest appearances on Charting The Market, a technical analysis television program hosted by Gene Morgan which aired on KWHY in Los Angeles. With the public appearances, interest in Sherman and Marian McClellan’s new indicators increased.

McClellan oscillator website

There are numerous websites where you can see data from the McClellan Oscillator applied to a wide range of stocks and indexes, but the main website for information about the indicator is this: https://www.mcoscillator.com

What is the market breadth?

Market breadth is the total number of stocks that are increasing in the price relative to the total number of stocks that are declining in a given index or on a stock exchange, such as the Nasdaq. Positive market breadth occurs when more stocks are advancing than are declining

What Does Market Breadth Indicate?

Traders and investors use market breadth to assess the overall health of the index. Market breadth can be a good predictor of an index price increase. It can also provide early warning signs of a future price drop.

Although valid, market breadth indicators do not always provide an accurate picture of the market. They may occasionally fail to predict future changes in the direction of price movements. Other times, market breadth may indicate a reversal far too soon.

When the number of stocks rising exceeds the number of stocks falling, there is positive market breadth. It signifies that market sentiment is bullish and indicates an increase in the prices of more individual stocks in the index.

A negative market breadth occurs when the stock prices of many companies decrease. It indicates that market sentiment is pessimistic, as seen by a drop in the stock index.

When the index increases and there is good market breadth, it is said to be a confirmation. On the other side, if the index is rising but there is negative market breadth or vice versa, it is said to be in divergence.

What is advanced-decline data?

The Advance-Decline (A/D) indicator is a technical indicator (check out our technical indicator guide) used by investors to calculate the number of individual stocks. The A/D line can tell you if the stocks are falling or rising with the market. The advance-decline (A/D) line is a technical indicator used in the stock market. It can aid in understanding individual stock movements as well as market performance.

How to Calculate the Advance-Decline Line

To calculate the Advance/Decline line, you remove today’s declining stocks from today’s advancing stocks, then add yesterday’s A/D line value.

[Today’s Advancing Stock – Today’s Declining Stocks] + Yesterday’s A/D Line Value

Importance of the Advance-Decline Line

The advance-decline line is significant for a variety of reasons. For starters, it assists investors in analyzing market performance and gauging the prevailing market sentiment.

It is also crucial since it can help provide a daily overview of deals, which is essential for investors. Finally, the A/D line is significant because it can reveal market divergence, which may indicate a potential market reversal.

Conclusion about the McClellan indicator (theory)

The McClellan Oscillator is a unique and by many regarded as a dependable tool for evaluating market breadth (what is market breadth?). Many broad-based indexes are market-cap weighted, which means that only a few of the largest companies within an index may typically change the index, so simply performing technical analysis on a broad-market index may not tell the real situation in the market. This is why the McClellan Oscillator might be a helpful tool for assessing the state of the market.

• S&P 500 Equal-Weight Trading Strategy

It might provide investors with a more realistic view of what every stock in the index is doing, not just the biggest ones at the top of the rankings. This is also true for the Summation Index, but it gives a more long-term view of the market when compared to the oscillator. The fact that these market breadth indicators can signal when money is coming in or going out is very important to investors.

This is the theory. Let’s move on to practice:

McClellan trading strategy (backtest)

We have above explained the basics and theory of the McClellan indicator, but let’s go on to actually backtest a trading strategy with specific settings and trading rules. We backtest S&P 500 (SPY) from inception (1993) until today.

First, let’s start with a graphical plot of what the McClellan indicator looks like in Amibroker (please read our Amibroker review):

As you can see, it oscillates up and down. First and foremost, we believe that McClellan is mostly used as an oscillating indicator.

McClellan trading strategy – backtest

Let’s backtest the a simple McClellan trading strategy. The trading rules read like this in plain English:

1. When the McClellan indicator crosses below -100, we long at the close.
2. When the McClellan indicator crosses above 100, we sell at the close.

The equity curve of this simple trading strategy looks like this:

This is not a particularly good equity curve even though the average gain is 1.2% over 97 trades (what is a good equity curve?). The equity curve is pretty erratic.

We tried many different settings for the buy and sell rules, but the results were for the most part pretty poor. The main problem with the McClellan indicator is that it can stay oversold for a pretty long time, like in 2008, for example.

That said, the McClellan indicator works pretty good if you use it together with other tools and indicator.

McClellan indicator strategy and backtest – ending remarks

While we only published one backtest of a McClellan indicator trading strategy in this post, we did numerous backtests of the indicator. And the conclusion is pretty clear: There are many other indicators that work much better. We have covered plenty of other possible robust trading strategies earlier, and not to mention our premium trading edges that you can find in our shop.

FAQ:

What is the McClellan Oscillator, and how does it work in the Nasdaq market?

The McClellan Oscillator is a market breadth indicator that measures the difference between advancing and declining stocks. When applied to the Nasdaq market, it becomes the Nasdaq McClellan Oscillator. It helps monitor the equilibrium between rising and falling stocks, providing insights into market sentiment.

What is the McClellan Summation Index, and how does it differ from the McClellan Oscillator?

The McClellan Summation Index is the long-term version of the McClellan Oscillator, representing a cumulative index of its values. While the Oscillator is more responsive to short-term trends, the Summation Index is used for medium to long-term timing, offering signals for bullish/bearish divergences, directional movement, and trend strength.

How does the McClellan Summation Index measure market sentiment and trend strength?

The McClellan Oscillator is versatile, measuring money flow into the market, identifying overbought/oversold conditions, and signaling potential reversals in market trends. The Summation Index determines bullish or bearish bias and trend strength by analyzing the sentiment of the market. It rises when the McClellan Oscillator is positive and falls when negative, reflecting the cumulative nature of market breadth over time.