Should investors fear the Hindenburg Omen?
For those of you who have never heard of the Hindenburg Omen it doesn't take a genius to work out that it's not a good thing given the origins of its name.
Named after the Hindenburg disaster of May 6 1937 it is a technical analysis chart pattern said to have originated from a couple of mathematicians, Jim Miekka and Kennedy Gammage.
Over the past few days we've heard a lot of chatter about the US stock market posting an unconfirmed Hindenburg Omen, with reports of eleven instances over the last two months, and while in of itself it is no guarantee of a crash it tends to make investors a little twitchy, especially as the last omen occurred just prior to the falls in 2009 and also occurred in June 2008.
So how does it work and what could it mean for investors. Put as simply as possible it involves the alignment of a number of different unrelated technical indicators that measure the normal day to day trading in the stock market, specifically on the New York Stock Exchange (NYSE).
The goal of the indicator is to warn of the likely probability of an equity market reversal or crash.
So let's look at how it works - the traditional definition of a Hindenburg Omen has five criteria:
1. the daily number of NYSE new 52 week highs and the daily number of new 52 week lows must both be greater than 2.2 percent of total NYSE issues traded that day.
2. That the smaller of these numbers is greater than or equal to 69 (68.772 is 2.2% of 3126). This is not a rule but more like a checksum. This condition is a function of the 2.2% of the total issues.
3. That the NYSE Composite index 10 week moving average is rising.
4. That the McLellan Oscillator, a popular market breadth indicator, is negative on that same day. This oscillator is created by taking a 19-day exponential moving average and a 39-day exponential moving average of the difference between the number of advancing and declining issues.
5. That new 52 week highs cannot be more than twice the number of new 52 week lows (however it is fine for new 52 week lows to be more than double new 52 week highs). This condition is absolutely mandatory.
These measures are calculated each evening using end of day data for consistency. The occurrence of all five criteria on one day is often referred to as an unconfirmed Hindenburg Omen which is what happened yesterday on the 12th August.
A confirmed Hindenburg Omen occurs if a second (or more) Hindenburg Omen signal occurs during a 36-day period from the first signal.
As with any trading system, because that is what this is, there will always be false positives or false negatives, whatever you like to call them.
Every indicator has its detractors, but according to Robert McHugh, a renowned financial investor "the omen has appeared before all of the stock market crashes, or panic events of the past 21 years, except the mini-crash of July/August 2011."
The statistics are also quite striking suggesting that the probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen was 77%, and usually takes place within the next forty-days.
One thing is certain, whether or not you believe in such indicators, given the current uncertainty of equity markets this past few weeks, investors would be well advised to be nimble when it comes to their investments, especially with so much uncertainty surrounding the timing of the Federal Reserve's tapering intentions and next month's German elections.
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