Problem: How can you tell if an index is about to reverse—even before the price reflects it?
Answer: Look at what’s happening internally within the index—in other words, analyze market breadth, also called “participation.”
Spotting a Rebound in a Plunging Market
Like most investors, you look to the three major indices—DJIA, S&P 500, and the Nasdaq—to get an immediate glimpse of the market. But when all three are cratering, like most of the sessions we’ve seen this week and last, you often won’t find any early hint of a rebound or reversal from the indices themselves.
Indices can be misleading because they don’t reflect the movement of individual stocks within them. They are market-cap-weighted, meaning a few big stocks can skew the picture, masking broader market trends.
What this means is that, if you’re looking for signs that the market may be turning more bullish amid a wave of selling, you need to look at what’s happening internally. Are all stocks and sectors following the decline, or are some starting to rise—even if their movements aren’t reflected in the index price?
Enter the McClellan Oscillator
The McClellan Oscillator is one of many market breadth indicators that track the internal movements of the stock market and, by extension, the indices that represent them. Breadth indicators can help confirm trends and, more importantly, expose underlying weaknesses in rallies or hidden strengths in declines, helping you spot potential reversals before they appear in price.
Specifically, here’s a nutshell description of how the McClellan Oscillator works:
- It measures market breadth, tracking advancing vs. declining stocks to give a clear picture of overall participation.
- A reading above zero indicates bullish momentum (more advancing than declining stocks).
- A reading below zero suggests bearish momentum (more declining than advancing stocks).
- Crossovers help identify trend reversals. A crossover above or below zero can confirm a shift in market momentum.
- Divergences also suggest potential reversals early on. If the oscillator moves opposite the index, it may signal that a reversal may be underway.
The last two points are what I will focus on in this article. Given the current tariff-fueled plunge, are any of the three indices showing signs of a potential reversal? And, if not, what should you look out for?
Let’s start with the S&P 500 ($SPX). Here’s a daily chart. For a more expansive breadth context, I am including the Bullish Percent Index (BPI) to show yet another angle on market breadth.
FIGURE 1. DAILY CHART OF THE S&P 500. Buyers are jumping in at the key 61.8% Fibonacci Retracement level. But does the overall participation support this reversal thesis?
Anticipating a downside target, I drew a Fibonacci Retracement from the (2024) August low to the December high. Bullish traders anticipating a rebound at the 61.8% level have started to enter their positions.
From a market breadth perspective, it’s too early to tell whether this key support level will signal a reversal. The NYSE McClellan Oscillator (a large portion of S&P 500 stocks trade on the NYSE) shows that declining shares within the index outweigh the advancing shares. The BPI reading, on the other hand, confirms this reading, as fewer than 50% of S&P 500 stocks are generating Point & Figure buy signals, a condition favoring the bears as it also signals technical weakness.
What to look for in the coming sessions: Notice the pink lines on both the chart and the McClellan indicator window signaling divergences. Look for bullish divergences or a crossover above the zero line in the coming sessions. However, don’t treat these as automatic buy signals. Instead, they suggest potential bullish conditions, suggesting you construct an entry setup if one presents itself.
Now, let’s look at a daily chart of the Nasdaq 100 ($NDX).
FIGURE 2. DAILY CHART OF THE NASDAQ 100. Declines are starting to stabilize as buyers enter the market, but it may be too soon to call a reversal.
The Nasdaq 100 shows a similar Fib Retracement reaction as in the S&P 500 example above; namely, buyers are jumping in at the 61.8% level.
The McClellan Oscillator remains bearish, but declines appear to be stabilizing (see pink lines). Notably, communications and healthcare stocks are slowing the drop. While not a bullish reversal signal, this shift could lead to a turnaround depending on how other sectors react in the coming sessions. Meanwhile, the BPI at 35%, tells you that the current price environment continues to favor the bears.
What to look for in the coming sessions. Similar to the previous S&P 500 example, keep an eye on the McClellan Oscillator readings for any bullish divergence or a crossover above the zero line. Remember, these signals indicate improving market breadth and potential upward momentum, but they are not automatic buy signals. Once a positive shift occurs, it’s going to require further confirmation from price action, volume, and other technical indicators before you jump into a trade.
A Two-Step Process
What I just demonstrated was a simple two-step process. Feel free to tweak it according to your preference. When a major selloff is underway…
- You need a means to forecast downside price targets. I used Fibonacci Retracements to set my downside targets (you can use other indicators to project potential support and resistance levels).
- Use a breadth indicator like the McClellan Oscillator to gauge how prices react to those downside targets. Namely, divergences and crossovers should alert you to the possibility of a reversal.
- Add other indicators to confirm the reversal when it happens. Don’t rely solely on one indicator; check price action, volume, and momentum, and have an exit plan in case it doesn’t follow through.
At the Close
Here’s the main point. You can use the McClellan Oscillator to anticipate turns in an index before it tips its hand, so to speak. It reveals shifts in market participation before such shifts become evident in prices. While major indices can be misleading due to their market-cap weighting, the oscillator focuses on breadth and momentum across all stocks and sectors comprising an entire index or market.
As of now, the S&P 500 and Nasdaq 100 show no clear signs of a bullish reversal. However, when a shift does occur, the McClellan Oscillator may be among the breadth indicators to signal it first—so keep an eye on it.
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.