McClellan Oscillator Explored – Part II (Extreme Values)
This is a multi-part series poking around the edges of the McClellan Oscillator (MO), a breadth indicator using the number of advancing and declining issues to measure the degree of participation in market moves (read more).
In my previous post, I looked at rising/falling and high/low MO readings and showed that what they’ve said about the markets has evolved over time, much the same way that similar indicators based purely on price have.
In this post I want to look at how the market (specifically the S&P 500) has reacted to extreme MO readings. We’ll look at three variations. I don’t purport that they are the best, or that they are what McClellan originally intended, but they are similar in spirit to how I usually see investors using the indicator.
[logarithmically-scaled]
A quick note before we start. Recall the graph above from the previous post showing the result of trading the S&P 500 index frictionless from 1950 based on whether the MO closed above (green) or below (red) zero.
Recall too that somewhere in the 1990’s, the relationship flipped from being momentum driven (i.e. positive MO readings led to positive gains) to being not predictive or even a bit contrarian. I want this post to be about what’s working now, so all of these tests will only cover from 2000 (to 04/17/2009).
Variation #1: Long when the MO is Low, Short when the MO is High
[logarithmically-scaled]
The graph above shows the result of going long the S&P 500 index at today’s close if today’s MO reading closed below -50 and short at today’s close if today’s MO reading closed above 50 in red, versus buy and hold (blue) from 2000.
Note: all of these results are frictionless (i.e. do not account for transaction costs or slippage), but for all intents and purposes, could be duplicated using mutual funds designed for active trading.
After I show the three variations, I’ll provide some stats and my own thoughts.
Variation #2: Long when the MO is Low, Short when the MO is High, Hold Until MO Recovers Enough
[logarithmically-scaled]
The variation above is long at today’s close if today’s MO reading closed below -50 and holding until it crosses above -40, and short at today’s close if today’s MO reading closed above 50 and holding until it crosses below 40.
Variation #3: Long when the MO is Low but Rising, Short when the MO is High but Falling, Hold Until MO Recovers Enough
[logarithmically-scaled]
And finally, this variation is long the S&P 500 index at today’s close if today or yesterday’s MO reading closed below -50 but is rising today and holding until it crosses above -40, and short at today’s close if today’s MO reading closed above 50 but is falling and holding until it crosses below 40.
Summary Stats
Thoughts
Does the McClellan Oscillator (all by itself) do a reasonable job in today’s market identifying when the market is extremely overbought/oversold? Sure.
But I think you would be hard pressed to say that these results are better than (or even as good as) other similar OB/OS indicators based purely on price such as RSI(2) (of course, I am very open to being proven wrong).
In my next post I’ll show why the MO doesn’t tell us much beyond what price already tells us, and in the post after that I’ll try to put my own spin on the indicator and turn it into something a bit more useful.
P.S. I know that some MO-proponents out there are saying, “yes michael, but it’s about the divergences between the MO and price, not just the MO”. All in due time good sirs…more to follow.
[Edit: click for a summary of all posts in this series on the McClellan Oscillator]
Happy Trading,
ms
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Filed under: Trading Strategies | 5 Comments
I think the thing you should be testing is MO being low, going long, MO being high, short. That’s what I meant by extreme reading in my last comment.
D – thanks for the catch – I completely backwardized that post. I ran the data the same as you expected (long high MO, etc) – I just wrote it all up backwards. Problem solved now. michael
One thing about the strategy is that it looks like it is in the market very little – so you’ve got the small sample size problem combined with what to do your money when you’re not in the strategy.
Agreed, but to be fair, I think you could say the same thing about any extreme OB/OS indicator (RSI(2), Bollinger Bands, etc). I think the same scaling concept we talked about for RSI(2) would make sense here too. michael
Don’t bother me with facts! ;)