The Hindenburg Omen: The Real Thing or Hot Air?

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This weekend
Zero Hedge reported
that on Thursday "the feared" Hindenburg Omen made an
appearance.

Wikipedia notes
that
:

Looking
back at historical data, 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.

The last Hindenburg
Omen occurred during the lows of 2009.

So is the Hindenburg
Omen the real thing or hocus pocus? First to the negative, it appears
that the discoverer of HO just ran various empirical back tests.
As far as I am concerned, it is not very impressive to find an indicator
via back testing and just running with it. In fact, empirical testing
as an investing method generally results in investments that blow
up; see Long Term Capital Management and subprime mortgages. That
said, I am never against looking at a formula to see if it can be
understood in terms of human action, to indeed see if it can show
some promise as a solid indicator. So let’s take a look at how HO
is determined:

The 5 Criteria
(Via ZH) That Must be Triggered for an HO moment to be considered
activated:

  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. 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 10-week moving average is rising.
  4. That the
    McClellan Oscillator (a market breadth indicator used to evaluate
    the rate of money entering or leaving the market and interpretively
    indicate overbought or oversold conditions of the market) is negative
    on that same day.
  5. That new
    52-week highs cannot be more than twice the new 52-week lows (however
    it is fine for new 52-week lows to be more than double new 52-week
    highs).

I like the
#1 factor in the formula. If you have strong activity at both ends,
highs and lows, to me this shows as a shifting market, with cross
trends – a very good sign of an unstable market.

#2 is a checksum,
so nothing to comment about here.

#3 A moving
10-week average indicates the market is high enough for a drop.
Obviously, stocks are more likely to fall from high levels than
low levels.

#4 This is
interesting. The McClellan Oscillator measures cash flow in and
out of the market. So if you a negative MO (cash flowing out) but
stocks up on a 10-week average, things are getting intense. Stocks
higher on less cash is always negative to me as it indicates money
is running out to support an advance.

#5 This is
also interesting, since in #1 we are detecting movement at both
ends. Here we are insuring that a significant part of that new high/new
low action is to the downside relative to new highs.

Bottom line:
I like this indicator. I wouldn’t bet my house on just this indicator,
but if you have slowed money supply growth (which we currently have)
and this indicator kicks in, things get interesting, since this
indicator is really telling you there is significant enough upside
action for a major drop, but at the same time something is already
causing downside action in other stocks plus cash is leaving the
market.

So with the
big question being: "Is HO the Real Thing or Hot Air?"
I have to go with a mildly enthusiastic, "It’s the real thing."
I can certainly think of scenarios where these factors could kick-in
with an upward moving market, but more often than not, it is signalling
what it purports to signal: A very weak upward moving market that
is setting up for major downside activity of 5% plus.

Read
the rest of the article

August
17, 2010

2010
Economic Policy Journal

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