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:
- 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.
- 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.
- That the NYSE 10-week moving average is rising.
- 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.
- 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.
August 17, 2010