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What Happens When the McClellan Oscillator Is Oversold?

The NYSE McClellan Oscillator (aka NYMO) is at its most oversold level since last November (in the correction just prior to the election).

With data going back to 1998, the current level (-77.73) is more oversold than 98% of other days. Historically, such extreme oversold levels have been followed by above-average returns over the next 1-12 months.

Does that mean the stock market always bounces when NYMO is oversold? No, there is no holy grail in markets and no such thing as always. You simply have a higher probability of a positive forward return than when the market is not extremely oversold.

There have been a number of times when an oversold NYMO reading was followed by a negative 12-month return. We saw this in 2001, 2007, 2008, and most recently, in 2014.

The September 2014 oversold data point was the only one since March 2009 that was followed by a negative 12-month return. The other 57 instances were all positive, followed by an average 12-month return of 21.1%.

The question, of course, is whether this going to play out like the 2007 data points or the many positive examples in recent years.

Unfortunately, that is question without an answer, because we cannot predict the future. The best we can say is that extreme overbought conditions in the McClellan Oscillator tend to lead to above-average forward returns with a higher probability of a positive short-term outcome than other periods. But these are just probabilities – there are many exceptions (most notably data points in 2001, 2007, and 2008).

Will the current reading fall into the “tend to” category or the “exception category”? We’ll only know in hindsight.

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Optical Illusions

Overbought, Oversold and the Great Paradox in Markets

Dead Cat Bounces and Armchair Contrarians

Interesting vs. Actionable

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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