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Finding Capitulation With The McClellan Oscillator at Trader’s Narrative

When I thought out loud about the strange market behavior of last Thursday, I pointed out the linkage with the carry trade. I’m a bit puzzled why I haven’t read that anywhere else. If you know of this issue being raised, please drop me a note with a link to where it was discussed.

Everyone has an explanation but in the end I don’t think we will definitively get to the bottom of what exactly caused Thursday’s vacuum of buy orders. In any case, rational analysis is interesting and fun but at the end of the day we are traders. Towards the end of my analysis I wrote (Stepping Into An Empty Elevator Shaft):

I would be looking to lean the other way into the Yen, Japanese bonds, US bonds and equities (for a very quick trade).

That was good for a very quick flip as things ‘normalized’ - thanks to the jaw dropping $955 billion EU bailout. Answering whether this is good for anything more than that is a bit trickier than relying on instinct.

Last week we saw two 90% down days and today’s gap and scream higher will most definitely provide a 90% up day. So we have the makings of a significant floor here as per Lowry’s work on 90-90 days (Charles Dow Award section, titled “Identifying Bear Market Bottoms & New Bull Markets”).

But was that really capitulation?

We can look at the family of McClellan Oscillator indicators to see if breadth was washed out enough for the market to form an intermediate bottom:

nasdaq mccellan oscillator May 2010
SPX compared to mccellan oscillator May 2010

As the recent market history shows, when the Nasdaq McClellan Oscillator (Ratio Adjusted) falls below -60 it sets up a very good condition for intermediate lows. However, it is important to note that this is the case during ‘normal’ markets. In severe bear markets, like in 2008, this indicator will be pushed to an even more extreme low. So the key is whether we are still in a cyclical bull market or not.

Turning to the other major market, the NYSE McClellan Oscillator fell to -358.6 - this is a super-low level for the indicator, as you can see from this chart:

McClellan AD NYSE Oscillator
Source: The McClellan Market Report

But it is common to see it stay very low for a little bit longer and create a positive divergence with the Dow Jones, setting up for an intermediate low. That’s why McClellan is looking for stock prices to find their footing later this week.

Another way to look at this is to ask what it would take to get the McClellan Oscillator to zero. Here is a chart showing the advance-decline difference that would be required the next day in order to move the McClellan Oscillator back to zero:

McClellan Oscillator to zero May 2010
Source: The McClellan Market Report

Tom McClellan, the son of the creators of the indicator, writes:

This number can also be useful in another way. When it gets to an extreme positive or negative value, it shows an extended condition for the market. This is the condition we see at the moment, in the wake of the stock market’s big decline this week on Greek debt worries and the “trading glitch” that sent the DJIA down briefly below 10000.

It is also worth noting that the extreme high values do not coincide with the final price low. They tend to arrive a few days ahead of the final price low, and so seeing a new extreme high value is a sign that the market is close to an important bottom, but not quite there yet.

So according to the McClellan Oscillator, the market will make a significant low later this week.

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12 Responses to “Finding Capitulation With The McClellan Oscillator”  

  1. 1 Alex

    I have discussed the McClellan oscillator Buy Signal in my daily report today available here (unfortunately, it’s in italian language, check out only the table). The MCO crosses under -300 10 times since 1990: 9-1 the S&P500 was positive after 49TD; 6-4 there was a MFE% at double digit gain. The same happened also after other periods such as 72TD and 92TD (optimized with Wealth Lab soft).

  2. 2 Ramon

    Babak, it seems this guy’s thinking was aligned in relation to the carry trade reversal, check this post out

  3. 3 Babak

    Thanks Ramon, another person suggested this article. Although it isn’t clear to me who wrote it.

  4. 4 Avi

    i guess it depends what “carry” trade you are talking about… obviously the long Euro short USD has not be in vogue for a while. But the ‘carry’ on 3month LIBOR (or June EuroDollar) was also a popular trade. It blew out on thursday as well (if you have futures charts, look for EuroDollar, June 2010)

    While LIBOR - OIS spreads are higher now than before thursday, they are still no where near the evevated levels of 2008

  5. 5 delbertino

    Schlossberg of GFT hit o usd/jpy;

  6. 6 Tom

    Great post Babak and it appears to be right on. I am attempting to become more systematic in my trading and this post feeds right into my efforts

  7. 7 Wes


    How do we reconcile “significant low later this week” from McClellan with Lowry’s 90-90 up day on Monday ? If I recall Lowry correctly, when the 90 up day occurs, the low is already in. My money is with Lowry on this.

    We’ve seen the quickest change in public sentiment from complacency to fear I’ve ever experienced. Check out the current put/call ratios, Arms Indexes, Rydex Ratio, etc. They have all flipped in the past week.

    And we’re still short term oversold.

  8. 8 ww


    Anything is possible here.

    On Monday, we had the largest one day VIX contraction (29.6%) since Oct 21, 1987.

    If you look at one day Vix contractions of greater than 21% they are

    1 week later 0-7 -4.19%
    1 month later 2-5 -3.72%
    3 months later 1-6 -5.99%

    Anything is possible.

  9. 9 ww

    Also, recall that we identified 30 days since 1970 where the S&P 500 sold off at least 5% intraday at some point. Of those 30, there were 11 that were 5% off there lows 3 days later. Of those 11, five retested the intraday low within 10 days of the that third day rally and seven at least retested the close of the capitulation day. That doesn’t make it likely, but simply makes it a possibility. Many of these cases were of course at the bottom of bear mkts. But these numbers plus the VIX numbers give me reason for concern. This is difficult for me, because I am intermediate bullish and fear missing intermediate move looking for short term pullback. The intraday low on cash was 1065.79 and the close that day was 1128.15, followed by a 1110.88 close the following day. Those two closing numbers look like feasible retracement numbers.

    These retest happen so fast, that your shortterm oversold conditions can still be met, as it is possible for a retest in a morning session and a positive close by the end of that day.

    I really can’t say with high confidence, but nothing will surprise me.

  10. 10 Wes


    I guess we all have doubts about the market, but the indicators I follow are almost perfectly bullish. Psychology is as bullish as it gets except at the bottom of bear markets, a 2 on a scale of 1 to 6 with 1 being most bullish. Valuation is a 1. Monetary conditions are constructive with an ideal yield curve and the market is short term oversold.

    Sure, it could go down again.

    But I’m not going to bet on it.

  11. 11 ww

    We agree the mkt should be higher 3 mts from now. I’m just concerned right now with the rest of this week.

  12. 12 Avi

    hahaha… how is valuation a 1?? have you looked at PE ratio’s? … sure the market can keep going up, but dont call it cheap!

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