McClellan Oscillator and McClellan Histogram
This lesson will cover the following
Developed by Sherman and Marian McClellan, the McClellan oscillator is a momentum indicator which measures market breadth based on the smoothed difference between the number of advancing and declining periods. It is similar to the broadly used Moving Average Convergence Divergence indicator (MACD) and is generally traded the same way. We will cover that a bit later after we discuss the calculation.
Although it was initially designed to trade stocks, the McClellan Oscillator has also been adopted to trade in the Forex market. It is used primarily for short-term and mid-term trading, where as the McClellan Summation Index, which we will cover in the next article, is in the handset of mid-term and long-term traders.
Best Forex Brokers for United States
The McClellan Oscillators calculation involves the estimation of the 39-period EMA of the difference between the number of advancing and declining periods (issues) and the estimation of the 19-period EMA of the difference between the same two components. The former is then subtracted from the latter. Thus, the formula looks as follows:
McClellan Oscillator = [19-Period EMA of (Advances – Declines)] – [39-Period EMA of (Advances – Declines)].
Here is how the McClellan Oscillator is visualized on a chart.
Chart source: VT Trader
Interpreting the indicator is quite straightforward. It is positive when the 19-period EMA (the faster one) is above the 39-period EMA (the slower one) and vice versa. When the MO is on the rise, it suggests that the market is overall on the rise. Conversely, when the 19 EMA is below the 39 EMA and the MO is negative, it implies that the market is overall edging lower.
Like we said earlier, McClellans Oscillator is similar to MACD, thus it is traded in an analogous manner. It generates long/short entry signals when the indicator switches sides on the scale, especially when it comes to major spikes (also known as breadth thrusts). A breadth trust occurs when the indicator moves sharply from negative into positive territory by as much as 100 points or more. A breadth thrust is further empowered by a bullish divergence preceding it.
Traders are also closely watching for both classic and hidden divergences between the indicator and the price, as well as determining overbought and oversold conditions. Divergences often precede moves in the indicator but a divergence solely is not reliable enough to warrant a successful trade, thus further analysis with the help of other tools is required. At the least, a divergence needs to be confirmed by a strong move in its direction, which reverses the previous trend.
A classic bullish divergence is at hand when the price marks a lower low, while the indicator rises to a higher low. A classic bearish divergence occurs when the price jumps to a higher high, but the indicator only manages to reach a lower high.
A hidden bullish divergence is at hand when the indicator marks a lower low, while the price only drops to a higher low. A hidden bearish divergence is evident when the oscillator marks a higher high, while the price is at a lower high.
The McClellan Oscillator can also serve to determine whether the market is overbought or not. Overbought conditions are generally implied when the faster EMA spikes and distances itself too far above the slower EMA, while the market is rendered oversold when it drops too far below the 39-period Exponential Moving Average.
The McClellan Histogram is a complement to the McClellan Oscillator and is used to assist the trader in identifying divergences and zero-line crossovers. It does so by plotting the difference between the McClellan Oscillator and its signal line in a histogram.
It is considered a momentum indicator and just like the McClellan Oscillator traders can jump on the market on zero-level crossovers. Additionally, market players also look for classic and hidden divergences and trade them the same way as described in the first part of the article. Here is a screenshot of the McClellan Histogram.
Chart source: VT Trader