Lately many economists and technicians have been noting a staggering development in the markets. There have been almost non stop editorials and discussions from news media from the likes of CNBC and CNN and Bloomberg. Lets define what the Hindenburg Omen is and see if we’re approaching this so called crash in the markets. The definition is from an excerpt from wikipedia.
The Hindenburg Omen is the alignment of several technical factors that measure the underlying condition of the stock market—specifically the NYSE.
The main goal of the indicator is to determine if a stock market crash has a higher likelihood than normal.
The Hindenburg Omen can also assess to a limited extent if a probability of a severe decline is on average higher than normal.
The general rationale behind the indicator is that “under normal conditions” either
1.A substantial number of stocks set new annual highs
2.A substantial number of stocks set new annual lows
3.Conditions 1 & 2 cannot both take place at the same time, it is either one or the other—but not both
However, this indicator mainly tracks new lows and downside risk. This is a part of its strength and part of its weakness.
A healthy market requires some degree of internal uniformity, whether the direction of that uniformity is up or down.
The traditional definition of a Hindenburg Omen requires that:
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. (Based on approximately 3100 NYSE issues the number required would be 69)
2.The NYSE 10 Week moving average is rising.
3.The McClellan Oscillator is negative on that same day.
4.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). This condition is absolutely mandatory.
These measures are calculated each evening using Wall Street Journal figures for consistency. The occurrence of all criteria on one day is often referred to as an unconfirmed Hindenburg Omen.
A confirmed Hindenburg Omen occurs if a second (or more) Hindenburg Omen signals occur during a 36-day period from the first signal.
The Hindenburg Omen mechanism can be applied to other stock exchanges like Paris, Frankfurt, Tokyo or Sydney but the criteria for it must overall be the same.
To eliminate false positives some technical analysts (as a rule) have imposed the condition that the Hindenburg Omen
“must be triggered 3 times in a row within a month from the 1st triggering event for said initial trigger signal to be considered to be valid”
must be valid when “all tightly coupled triggerings are within a fortnight” (14 working days)
will indicate a possible future downturn or correction, depending on the magnitude of any “one off” triggering
One off Hindenburg Omen signals are always considered unconfirmed as the indicator has a high false alarm rate. A train of 3 to 5 coupled Hindenburg Omens are preferred by analysts wherever possible.
The 2.2% number seems to be tied to (or gives the appearance of being) the average growth within the US economy since 1955, an average of only about 2%. The original creators of this signal have not fully explained their use of 2.2% constant, but apparently chose it because that was the number that their back-testing of market data showed was statistically meaningful.
The condition of the “NYSE 10 Week Moving Average is rising” may be subject to tweaking up or down 3 or 4 weeks. This condition’s overall role in removing noise of the weekly flux of the stock market is unclear or not well understood.
The effects of the recent merger of the NYSE with Euronext may have an effect on future predictions, but it is assumed that carefully filtering out non-US stocks from the triggering signal may restore the signal to its original functionality.
A small family of Hindenburg Omens (with minor changes in each one) performing as a voting block could potentially perform better than the single voting mechanism in place right now (with its mechanisms to avoid false triggering).
The Hindenburg Omen indicator was devised during the longest peacetime economic growth in US history (1955-2007). It is totally unknown how it will cope with multi-year or quarter century economic depression conditions.
Central bank intervention in the stock market can interfere with the triggering mechanism of the Omen. It must be noted that the triggering conditions—with respect to central bank intervention—are quite difficult to manipulate. Most of the Omen’s indicators are long term and of a broad market nature. Central banks intervening in the market to keep the Hindenburg Omen from triggering is unknown as there are related market triggers to indicate a downturn is coming—and this one is probably the hardest and costliest to rig.
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 probability of a panic sellout was 41% and the probability of a major stock market crash was 24%.
However, the occurrence of a confirmed Hindenburg Omen does not necessarily mean that the stock market will go down, although every NYSE crash since 1985 has been preceded by a Hindenburg Omen.
Because of the very specific and seemingly random nature of the Hindenburg Omen criteria, it is possible that this phenomenon is simply a case of overfitting. That is, if one backtests through a large data set and tries enough different variables, eventually correlations are bound to be found that don’t really have any predictive significance.
The fact remains that out of the previous 25 confirmed signals only 8% (two) have failed to predict at least mild (2.0% to 4.9%) declines, so it is at best an imperfect technical indicator that is a work in progress.
Recent occurences:
August 12, 2010: An unconfirmed Hindenburg Omen occurred, the first since the market lows of 2009. One nearly occurred on August 11, failing only in that 67 stocks hit new lows, rather than the required 69.
June 22, 2007: There were 3,422 NYSE issues traded, with 88 New Highs and 73 New Lows, the lesser number equal to 2.13 percent of total issues traded, almost 2.20 percent. The McClellan Oscillator was negative -116.59.
June 21, 2007: There were 3,434 NYSE issues traded, with 106 New Highs and 75 New Lows, the lesser number equal to 2.18 percent of total issues traded, almost 2.20 percent. The McClellan Oscillator was negative -36.65.
June 13, 2007: There were 3,428 NYSE issues traded, with 96 New Highs and 95 New Lows, the common number equal to 2.77 percent of total issues traded, above the minimum requirement of 2.20 percent. The McClellan Oscillator was negative -116.92.
SOURCE: WALL STREET GRAND JOURNAL
