Summation Index Signals

Since our time frame encompasses three- to six-month swings, most of our attention will be on the McClellan Summation Index. In Chapter 2 , I explained that when the NYSE Summation Index trades above +3,500 and then closes below +3,500, it is a "shot over the bow" or a warning signal that the NYSE may be nearing a top. In general, that condition will indicate a topping process has begun when used in conjunction with the other two filters of volume and momentum. In other words when the NYSE Summation Index has turned downward from over the +3500 level, volume has triggered bearish signs as well, and momentum (as measured by the weekly moving average convergence/divergence [MACD] or Price Momentum Oscillator [PMO] indicators) has also turned down, then conditions in all three analyses have been met and a downtrend may be underway. In this chapter, I will give further details for buy and sell signals generated by analysis of breadth, volume, and momentum.

In the years to come, the overbought and oversold levels for the Summation Index may change, but that should happen gradually, allowing us to make accurate adjustments. Figure 6.1 shows the McClellan Oscillator and Summation Index for the NYSE dating back to 1996. It shows the boundary lines over overbought and oversold levels for the NYSE Summation Index in different time frames.

Figure 6.2 shows that, in general (starting in 1996 and ending mid-2007), the NYSE was approaching a high when the Summation Index was greater than + 3,000 and, in general, it was approaching a low when the Summation Index was below —500.

In Figure 6.3 , going back to 1996, I have identified the areas where capitulation in the NYSE occurs when the McClellan Oscillator records readings below —230. Readings below —230 on the McClellan Oscillator predict the market is at extreme oversold levels, which is the type of condition that appears near intermediate-term bottoms. The McClellan Oscillator reading below —230 is the first sign the NYSE is approaching a low. Bear market will not achieve a McClellan Oscillator reading below —230. The —230 (preferable lower) reading on the McClellan Oscillator shows capitulation which is the condition that appears at bottoms. As more issues are added to the NYSE in the coming years, the advance/decline line will have higher and lower extremes and increase the capitulation level of the McClellan Oscillator. Right now McClellan Oscillator readings below —230 is and indication the NYSE is near a bottom.

Notice in early 2007 that the McClellan Oscillator hit below — 300 and predicted a bottom, while the McClellan Summation Index was at an overbought level near +4,000. It is said that an overbought market can last longer than a trader who is short the market can remain solvent. Here, the

FIGURE 6.1 McClellan Oscillator and Summation Index for NYSE from through Q1 2007

Source: Chart courtesy of

FIGURE 6.1 McClellan Oscillator and Summation Index for NYSE from through Q1 2007

Source: Chart courtesy of

McClellan Oscillator reached a climatic low below —230, which predicted an intermediate-term significant low. This condition implied that the McClellan Summation Index would remain overbought for a while longer.

Remember, there are no absolutes in technical analysis, only probabilities. Once the McClellan Oscillator hits below —230 to indicate the NYSE has hit capitulation, to confirm a bottom in the NYSE, the McClellan Oscillator should switch immediately and rally to +175 or higher to show that the advance/decline line has switched from down to up. This two-step process on the McClellan Oscillator can be found at all significant lows on the NYSE. After the McClellan Oscillator reaches past +175 to confirm a bottom, the NYSE can pull back and test the previous low (like it did in

FIGURE 6.2 McClellan Oscillator and Summation Index for NYSE, with Summation Index Showing Overbought Conditions above +3,000 and Oversold below -500

Source: Chart courtesy of

FIGURE 6.2 McClellan Oscillator and Summation Index for NYSE, with Summation Index Showing Overbought Conditions above +3,000 and Oversold below -500

Source: Chart courtesy of

mid-2004) or stall in a sideways pattern for a short while then work higher (like in mid-2007). What is important in determining a bottom in the NYSE is that first the McClellan Oscillator must reach capitulation with a read below —230 and then hit +175 or higher to show strength in the advance/ decline line and confirm the bottom. I might add that McClellan Oscillator readings much lower then — 230 (say near — 350 or lower) imply a greater degree of capitulation and therefore a larger degree bottom (and therefore expect a longer lasting rally). Also the McClellan Oscillator reading after the capitulation reading that reaches past + 200 imply the coming rally will be much stronger than if the McClellan Oscillator reached just +175 range. In Figure 6.4, I pointed out these instances—where the McClellan

FIGURE 6.3 McClellan Oscillator Shows Readings below -230, Which Indicate Oversold Conditions and Predict a Bottom Source: Chart courtesy of

Oscillator went below —230 and then rose to above +175 to confirm a bottom—going back to 2004. This chart also shows the oscillator reading touching below —300 and then reaching near +200 in early 2007 and predicted the rally that followed.

Figure 6.5 is the NYSE Index, showing the McClellan Oscillator and Summation Index from January 2004 through April 2007. The boundary for the NYSE Summation Index changed in that time frame to an overbought level of + 3500 and to an oversold level of below — 500. Since 2004, the first sign of trouble in the market is when the Summation Index traded above +3,500 and then closed below +3,500. This condition is a "shot over the bow" as the advance/decline line is starting to contract as

FIGURE 6.4 McClellan Oscillator Readings below -230 to Indicate Oversold and Then above +175 to Confirm a Bottom Source: Chart courtesy of

the market is moving higher, which is a bearish condition. This shows that there are now fewer stocks carrying the rally higher.

Since 2004, when the NYSE Summation Index turned down from + 3,500, the subsequent high was lower, while the NYSE made a higher high, which showed fewer stocks were carrying the rally and created a negative divergence.

FIGURE 6.5 NYSE McClellan Oscillator for 2004 through April 2007 Source: Chart courtesy of

The NYSE McClellan Summation Index also helps you to identify when conditions, which once were bearish, have turned back to bullish. Direct your attention in Figure 6.5 to the area dated October 2004. At that time, the Summation Index had turned down from a high of over +4000 and closed below +3,500, which was a bearish sign. Then, in early November 2004, the Summation Index turned back up, hitting a higher high above its previous high of +4,000 along with the NYSE. This showed that the Summation Index had found new energy as the advance/decline line strengthened and broke to new recent highs—thus showing that more issues were carrying the rally forward. This was a bullish condition.

Once the Summation Index turns down from a high above +3,500, to keep the bearish scenario the Summation Index should not trade above its previous high in the topping episode. If it does, then the uptrend has been renewed and the market (NYSE) should head higher. Likewise, when the Summation Index turns down from above + 3,500 and the NYSE makes higher highs and the Summation Index makes lower highs than the previous high, the bearish scenario is reinforced.

When the NYSE McClellan Summation Index turns down from above + 3,500, it is a "shot over the bow." What comes after that warning sign is a sell signal setup for the NYSE Summation Index, as follows:

• The second high on the Summation Index is lower than the first high, and the NYSE has made a higher high. This condition shows that fewer issues are carrying the market higher and creates a bearish breadth divergence.

• The second low of the Summation Index trades below the first low, which shows the downward momentum in the advance/decline line).

• The Summation Index turns down again, triggering the sell signal.

Figure 6.6 for NYSE shows sell signals since 2004. In all cases the Summation Index produced a "shot over the bow" warning sign that started the sell- signal setup process. I have numbered the tops on the Summation Index as "1" and "2," indicating where the Summation Index made lower highs—the first step of the sell-signal process. I numbered as "3" the point on the Summation Index where the second low is lower than the first low, which shows downward momentum on the advance/decline line. Next, I marked with an arrow where the Summation Index turned down after the second low and triggered a sell signal.

As you can see, this method did a good job of identifying where and when weakness was entering the market and triggering sell signals that were either at the top or close to it. Notice in Figure 6.6 that in April 2007 all three requirements were met for a sell signal triggered by the NYSE Summation Index: The Summation Index reached the overbought level of +3,500; the NYSE made higher highs while the Summation Index put in lower highs, creating a bearish divergence; and the second low in the Summation Index was lower than the first low, which showed downside momentum in the advance/decline line and a bearish condition. The Summation Index would need to turn down to complete the sell signal.

FIGURE 6.6 NYSE McClellan Oscillator, Marked with Significant Tops (1 and 2), Lower Second low (3), and Triggering of Sell Signal (arrow) Source: Chart courtesy of

However, the Summation Index in late April traded above the previous high and triggered a bullish signal, negating the bearish setup. Also notice that the McClellan Oscillator hit below —230 and then traded above + 175 to trigger a bullish signal. As I have said, tops usually take longer to develop and take more study to identify.

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