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  • Timing the Markets with the Magnificent McClennan Oscillator 1 comment
    Oct 17, 2011 7:40 PM

    The last three years have been some of the most volatile, violent, and eviscerating years ever experienced in the stock market.

    Traders have been hit with a lethal lexicon of capital destroying phrases: black swans, peak oil, sub-prime mortgages, corporate bankruptcy, flash crashes, earthquakes and tsunamis, nuclear meltdowns, sovereign insolvency, debt contagion, recession, compression, depression. 

    It has been a never-ending barrage that I'm sure has left many traders and investors shell-shocked. Just when it feels that it might be safe to poke your head out of the trading trenches, another apocalyptic shell comes screaming overhead threatening to blow the whole global financial system into smitherines.

    And yet in the midst of this chaos and volatility there have been tremendous trading opportunities - both to the upside and to the downside.

    Being an optimist I prefer to make money when things go up - I don't have the streak of cynicism required to be a successful short trader. So I spend my days looking for tools that can help me identify opportune entry points into the markets after they have been decimated by the latest crisis du jour.

    One tool that has been extremely effective - in fact, it has a perfect batting average since August 2010 - is the McClennan Oscillator.

    The McClellan Oscillator is a market breadth indicator used to evaluate the rate of money entering or leaving the market and interpretively indicate overbought or oversold conditions of the market.

    To have a look under the hood of this oscillator, click on the following: en.wikipedia.org/wiki/McClellan_Oscillator#How_it_works

    The McClennan has successfully identified the bottom of every market sell-off since August 2010.

    Below is the chart for the McClennan since August 2010, and below that is the chart for the SP500 over the same period.

    You can see that whenever the McClennan dipped below -60 it signalled the end of a market sell-off.

    Once the McClennan dips below -60, however, it is difficult to know how low it will drop. It is thus prudent to wait for it to bottom out and close back above -60 before establishing a LONG position in the SP500.






    Let's take a look at the results:
     

    1. August 2010 - the Buy Signal was generated on August 25, 2011 when the McClennan climbed from below -60 and closed at -48. Since the McClennan is calculated after the close of each trading day, it can only be acted upon on the following trading day. On August 26, 2010 a LONG position could have been taken with the SP500 closing at 1,047. The SP500 peaked on November 5, 2010 at 1,225 - this was a bullish run of 17%.
    2. November 2010 - the Buy Signal was generated on November 18, 2010 when the McClennan climbed from below -60 and closed at -30. On November 19, 2010 a LONG position could have been taken with the SP500 closing at 1,199. The SP500 peaked on February 18, 2011 at 1,343 - this was a bullish run of 12%.
    3. March 2011 - the Buy Signal was generated on March 17, 2011 when the McClennan climbed from below -60 and closed at -54. On March 18, 2011 a LONG position could have been taken with the SP500 closing at 1,279. The SP500 peaked on April 29, 2011 at 1,363 - a bullish run of 6.5%.
    4. June 2011 - the Buy Signal was generated on June 9, 2011 when the McClennan climbed from below -60 and closed at -42. On June 10, 2011 a LONG position could have been taken with the SP500 closing at 1,270. The SP500 peaked on July 7, 2011 at 1,353 - a bullish run of 6.5%.
    5. August 2011 - the Buy Signal was generated on August 11, 2011 when the McClennan climbed from below -60 and closed at -28. On August 12, 2011 a LONG position could have been taken with the SP500 closing at 1,178. The SP500 peaked on August 31, 2011 at 1,218 - a bullish run of 3.3%.
    6. September 2011 - the Buy Signal was generated on September 23, 2011 when the McClennan climbed from below -60 and closed at -42. On September 26, 2011 a LONG position could have been taken with the SP500 closing at 1,162. The SP500 peaked on October 14, 2011 at 1,200 - a bullish run of 3.2%.
    The McClennan can also be useful in identifying when markets are overbought (a close above 60) but it is more effective as an indentifier of market bottoms. Markets often peak before the McClennan rises above 60 and a close above 60 can sometimes indicate a period of consolidation rather than the beginning of a significant sell-off.

    The McClennan can help you get into a LONG trade, but unfortunately it is not of much help when it comes time to decide when to close the trade for a profit. I have not been able to identify a pattern in the McClennan that can help determine when a rally has peaked. 

    Like most technical indicators the McClennan is not perfect but it can help muster the courage to go LONG when everyone else is running for the hills.

    Determining how to maximimze the gains on each McClennan Bullish Signal is still a work in progress - an update will be provided once (if) a reliable 'rally peak signal' has been identified.




    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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  • Disciplined
    , contributor
    Comments (4) | Send Message
     
    Thanks for the great explanation. The daily McClellan Oscillator is currently at 91.33, which had been a leading indicator of a short-term top, but here it bounced from a level around 40. Does that impact the interpretation of the Oscillator?
    24 Oct 2011, 11:44 PM Reply Like
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