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fib_1618

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Please note that this tutorial is taken from a question asked about MCSUM divergences on the Traders-Talk forum in November of 2011. The complete post, along with the thread itself, can be found in its entirety by clicking the following link -  http://tinyurl.com/73w4o2o

The McClellan Summation Index measures the difference between two exponential moving averages that follow the directional cumulative trend of the NYSE advance/decline line. The shorter term 10% Trend measurement of the NYAD line is represented by a 19 day EMA, while the intermediate term 5% Trend measurement is a 39 day EMA. If we take away the raw data of the NYAD line itself, and looked at just the travel of these two EMA's themselves, it would look like this:



As notated on the chart, the spread of these same "Trendlines" represents the amount of energy (money, liquidity) moving in to or out of the market, as measured by the cumulative A/D data, at any given point time. The wider the spread between the two EMA's, the more dynamic the flow of this same money flow component. This is the same conceptual application that one uses to measure the trend strength of a simple price pattern structure as well. Now although this smoothing effect between the two time period trends is nice to know, it doesn't really tell you the speed in which these two EMA"s are moving independently in relation to the A/D line, no less, their interplay between the two. This is where the McClellan Summation Index comes into play. With the use of its sister tool, the McClellan Oscillator, this indicator is then able to give you a visual way to understand both of these EMA dynamics as shown with the next chart:



The first and foremost understanding of this tool is that it measures the distance between the two EMA's discussed earlier. When the two EMA's cross each other, this is where the zero line resides on this oscillator. I have highlighted two recent crossovers on the chart in yellow as examples. So just on a cursory view of this tool, one can always know the position of any cumulative breadth or volume data, and its trend spread, which then allows the knowledge of whether the underlying flow of money is either expanding, contracting, or showing a change in direction on an intermediate term trending basis. This is probably the most important piece of information that any trader, of any time frame, can have and know. For with this knowledge, you're already aware of what your odds will be of a successful trade (before going in) if one either goes with (or against) this same wave of expansion (or contraction) of liquidity...which is the absolute determining factor of which direction prices are likely to move as a result of this same stimulus (or lack there of).

The other visual you can take from this is that the individual postings themselves represent the daily readings of the McClellan Oscillator. Since this oscillator measures the speed in which money is either moving in or out of the market on a short term trending basis, the further the post expansions, the more control one side has over the other on this same trending basis (buyers to sellers, sellers to buyers). Therefore, the further the distance between one daily posting and the other, the more dynamic the buying or selling on that particular trading day. This would also mean, the more congested the postings might be, the more indecision there is between these two sides of investment opinion.

Lastly, since breadth (or money) leads the direction of price itself, we can then use the EMA components that make up the McClellan Summation Index as a proxy as to the strength or weakness that accompanies each price structure as shown in chart 3 below:



The simple way to look at this is that as long as the directional trend of money supports the direction of price, the trend remains intact. If you have divergences, then you can eventually expect a change in this same trend. Some divergences occur as Type 1 where this A/D component makes a lower high, but prices go on into new territory without the benefit of this same money flow component. These are almost always "terminal" events to the larger price structure overall. But there is also Type 2 divergences where the A/D line moves to higher highs, while prices fail to do so. Divergences like these, the same as we had back in July, are almost always "correctional" points in this same structural pattern. So far, this is exactly what we've had to work with over the last several months.

So to answer your question about divergences, in a general sense, we can have many before a change in direction is triggered. Much of this really depends on how much energy is being used and applied, and then whether or not there's anything left to use when the tank gets close to being empty. Right now, with monetary policy around the globe giving us levels of liquidity never seen before in history, it's not likely that we're going to see Type 1 divergence between the NYSE advance/decline line and the New York composite index for an extended period of time. And based on the fact that there's never been a time since 1926 when we haven't seen Type 1 divergence first before a bear market began, increases the odds that until we do, the longer term trend will continue to remain up overall.

2011 Technical Watch

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