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Why You Can't Afford to Ignore the Hindenburg Omen

June 17th, 2013
in contributors

Money Morning Article of the Week

by David Zeiler, Associate Editor, Money Morning

The Hindenburg Omen-a harbinger of stock market crashes-eerily appeared again last week ... and the Dow Jones promptly dropped 205 points. But its appearance brought mostly scorn from the mainstream financial media.

Here are just a few of the headlines from the past week:

  • "Hindenburg Omen is Just Hot Air"
  • "Why 'Hindenburg Omen' Is Just a Superstition"

And our personal favorite:

  • "Hindenburg Omen is idiotic, and if you believe in it, you should lose your right to own stocks-or anything"

Several Wall Street analysts reacted as if even being asked about the Hindenburg Omen offended them.

Follow up:

Adam Grimes, Chief Investment Officer at Waverly Advisors., told The Wall Street Journal

"Let's not mince words on this subject: This is an example of the worst kind of 'technical analysis' - a market signal essentially designated for media sound bites. The markets may well decline from this point, but they will not do so because of some cleverly named signal. The Hindenburg Omen, we have to say, is mostly hot air."

Non-believers in the Hindenburg Omen say it correctly predicts a stock market crash only 25% of the time, and point out the last time it appeared, in 2010, the markets just kept on rising.

Daryl Guppy huffed on the CNBC Web site -

"In 2010 the accuracy of the 'Hindenburg Omen' indicator went up in flames and the current situation suggests the same result in 2013."

Yet an appearance by the Hindenburg Omen has preceded every stock market crash but one since 1985, and if you look closely at the numbers this indicator's track record is remarkably accurate.

Maybe the doubters don't know as much as they think they do.

Money Morning Chief Investment Strategist Keith Fitz-Gerald, who called the Hindenburg Omen one of his favorite indicators, said -

"They call it bogus because they don't understand it."

A Hindenburg Omen Raises the Chances of a Stock Market Crash

The Hindenburg Omen is a complex set of conditions that all must be met for an occurrence to be valid. Take a deep breath:

  • The number of New York Stock Exchange 52-week highs and lows must both be greater than 2.5% of the total issues traded that day.
  • The smaller of the 52-week highs and lows must be greater than or equal to 79.
  • The NYSE's 10-week moving average must be rising.
  • The McClellan Oscillator, a measure of market breadth based on exponential moving averages of advancing and declining stocks, must be negative.
  • The number of 52-week highs cannot be more than twice the number of new 52-week lows.
  • The first occurrence of a Hindenburg Omen must be matched by at least one more within 36 trading days for there to be "confirmation" of the signal.

Once a Hindenburg Omen signal has been confirmed, the probability of a market downturn within the next several months of 5% or greater is 67.8%. Here's the likelihood of progressively more severe drops:

  • Probability of an 8% decline or more: 48.5%;
  • Probability of a panic sell-off of 10% or more: 35.6%;
  • Probability of a full-blown stock market crash of 15% or more: 25.8%.

We've recently had three occurrences (more than two is considered a cluster) of the Hindenburg Omen within 36 days - April 15, May 31 and June 4. The Dow slipped 1.4% yesterday, so the predicted downturn may already be underway.

Click to enlarge

Why the Hindenburg Omen Works

Fitz-Gerald said many mainstream financial analysts disregard the Hindenburg Omen because they view the stock market through technical goggles. They see the Hindenburg Omen as a flawed technical indicator, but it was never meant to be a technical indicator.

What the Hindenburg Omen measures is market psychology, which Fitz-Gerald said is a primary force in driving the market.

Fitz-Gerald said,

"The mainstream guys are trapped in the ethos of quantifiable economics, so they dismiss it. They're busy assessing the technical merits of an industry fundamentally psychological in nature."

In fact, he said, the Hindenburg Omen has more in common with better-known socio-economic indicators like skirt lengths than the technical indicators that most Wall Street analysts study.

Socio-economic indicators correlate the relationship between human behavior and how the markets are performing, and Fitz-Gerald says they're usually far more accurate than the purely technical indicators most of Wall Street fixates on.

In the case of the Hindenburg Omen, Fitz-Gerald is so impressed with its predictive capabilities that he's developed his own version of it based on proprietary data.

Fitz-Gerald said,

"This stuff is not only real, but if you learn to understand it, it's profitable."

Clearly, he's taking the latest occurrence of the Hindenburg Omen seriously, but advised investors not to panic at the possibility of a stock market crash.

Fitz-Gerald said,

"There's no need to run and yell and scream and put your head in the sand. But do be on your guard. Tighten up your trailing stops. Harvest profits. Invest with caution."

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