There is a rare but widely-reported technical signal in the stock market named after the 1937 disaster called the “Hindenburg Omen.” The signal was originally defined and identified by Jim Miekka, who writes a popular, technically based newsletter. As you might imagine, the Hindenburg Omen is a bearish technical signal that is supposed to indicate a high risk for a major market drop.
The ideas behind the Hindenburg are very interesting, and on the surface they seem very compelling. The criteria for the signal consists of a series of market-breadth and sentiment indicators. When sentiment becomes extreme, the signal is triggered, and some traders may decide to take profits before the predicted crash.
- At least 2.8% of the stocks on the NYSE should be hitting new highs and new lows on the same day. This should indicate an extreme level of trader indecision.
- The NYSE index should be higher than it was 50 days ago.
- The McClellan oscillator, which measures buying and selling pressure, should be negative.
- The number of new 52-week highs shouldn’t be more than twice the new lows.
Traders ignore sentiment and market-breadth indicators at their own peril. However, if you are getting the impression that the Hindenburg signal is strangely “specific,” you are probably onto something. This smells like an over-optimized technical signal that has been added to and modified over time to better fit past examples. That is true, but it still shouldn’t be completely ignored.
We can’t draw very good conclusions from the Hindenburg because the definition has changed so much over time. However, it’s basically an enhanced version of another indicator called the “High-Low Logic Index,” created by Norman Fosback in the 1970′s. So if we ignore the over-optimized Hindenburg and go back to traditional market-breadth and technical indicators, can we tell if the market is headed towards a fiery crash?
The answer to that question is a little hazier than advocates of the Hindenburg would have you believe. It is true that market-breadth indicators are a little weak right now. You can see the NYSE High-Low Index, which is similar to the indicator the Hindenburg is based on, in the next image. The trend is negative, but looks much like it did in the middle of April. Becoming overly bearish at that time would have been a very bad idea.
We find that price indicators provide a much better view of the market than market-breadth indicators. They are currently adding a little more weight to the argument that some short-term bearishness would not be a surprise, but in an uptrend you have to consider dips to be buying opportunities.
Click to EnlargeFor example, in the chart at right you can see the S&P 500 with a MACD oscillator applied. There is a bearish divergence consisting of higher highs on the index, and lower highs on the MACD.
This same thing happened in March and September of 2012, which accurately predicted small dips to support. It would not be unexpected to see that happen again this quarter. The difference between a more traditional analysis like this and the Hindenburg is not just over-optimization. There is a major difference in the scale of the decline predicted by both approaches.
The Hindenburg is popular (despite its bad track record) because it is supposed to predict market crashes. That makes it great fodder for financial writers using it for “click-bait” on blogs and financial websites. In contrast, divergences and minor bearishness in the traditional breadth indicators suggest that we are at risk of a small decline of 100 points or less on the S&P 500. So who is right? Should traders expect a crash or a mild dip where stocks are likely to bounce again?
Eventually the Hindenburg Omen will probably be right, but so far all the “crash” signals since 2009 have failed, which is a long time to be wrong. Investors tend to be pessimistic by nature because they have to suffer the pain of losses when they are wrong, but being too pessimistic can be much more dangerous. The bottom line is that the market does seem to be setting up for a pullback, but we will go with the historical trend and assume it’s more likely to be a short-term than long-term trend change.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.