Capital Gold Group Report: Hindenburg Omen: Is a Stock Market Crash Imminent?

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8/13/10 – Written by Eric Rosenbaum from New York.

NEW YORK (TheStreet) — It may just be the summer doldrums, or the ominous occurrence of a Friday the 13 in mid-August, but the Hindenburg Omen — a technical indicator of an impending stock market crash — is suddenly as important a market mover as testimony from Federal Reserve chairman Ben Bernanke.

The blog Zero Hedge, writing in a vein that seems made for professional boxing or WWE pay-per-view event hype, describes the Hindenburg Omen as “Easily the most feared technical pattern in all of chartism (for the bullishly inclined). Those who know what it is, tend to have an atavistic reaction to its mere mention.”

Hindenburg

In case you hadn’t heard, Thursday’s action on the New York Stock Exchange registered a technical anomaly known as the Hindenburg Omen. Read: just like the doomed German airship, the markets are fated to crash and burn. Still worse, Wednesday’s trading action almost sparked Hindenburg Omen conditions. It takes two Hindenburg Omen trading days within a 36 day window to trigger the end of life in the markets as we know it.

Writing on RealMoney.com, Rev Shark notes of the market voodoo that “the logic behind this ominous-sounding indicator is this: When there are internal inconsistencies in the market that are causing a simultaneously high level of new highs and new lows, a greater risk exists that the resulting confusion and uncertainty will cause market players to exit… When the herd is confused and moving in two different directions, internally that is going to cause some problems.”

But first the facts. There was a correction in the markets this week, and the sell-off triggered the Hindenburg conditions. The Hindenburg Omen occurs when an unusually high number of companies in the New York Stock Exchange reach 52-week highs and lows at the same time. The proportion of  NYSE stock highs and lows must both exceed 2.2% of the total listed on the exchange. The Hindenburg Omen last occurred in October 2008, according to UBS data.

Additionally, the Hindenburg Omen is only valid in a rising market — as measured by the NYSE composite rolling average over the past 10 weeks; the number of stocks at a 52-week high must not be more than twice those stocks at a 52-week low, and the Hindenburg set of apocalyptic conditions must occur twice in a 36 day period.

And that’s not all. The Hindenburg Omen perfect storm must also include a negative measure in the NYSE McClellan Oscillator, a measure of market momentum. If it sounds like the flux capacitor of Back to the Future, you just don’t know how to trade the charts.

The Hindenberg Omen does have a decent track record. A UBS strategist told Bloomberg that the Hindenburg Omen signaled itself seven times in 2008, before the S&P posted its biggest annual drop since the Great Depression. A confirmed Hindenburg Omen has occurred prior to every major stock market crash crash since 1985, according to various market sources with their finger on the panic button.

Jason Goepfert at Sentimentrader.com told RealMoney’s Rev Shark that the Hindenburg Omen does have a fairly good track record of predicting weakness, especially when there are a cluster of such Omen days in a short time frame. The average return of the S&P 500 three months after the Omen is triggered is a loss of 2.6%, and the market was positive only 29% of the time.

In the mood for some more Hindenburg Omen doomsday numbers? The probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen was 77%, according to historical data quoted on Benzinga. It usually takes place within 40 days of the first Hindenburg event. The probability of a panic sellout was 41% and the probability of a major stock market crash was 24%.

That said, there are plenty of Hindenburg false alarms, too — and, for that reason, some analysts claim that it requires not just two, but between three and five Hindenburg events within a 14-day window to really send the signal to take the chips off the market table.

Anyone ready for a game of craps or roulette? Maybe we should just put all the money under the mattress at this rate and hope the Hindenburg doesn’t crash over our houses.

Some fear that the Hindenburg Omen is a self-fulfilling prophecy. Convince enough investors that the Omen exists and they will start selling en masse, causing a market crash.

One can argue that regardless of the Hindenburg Omen or not, more accepted technical indicators are not looking particularly good, so any equity investor out there who isn’t already cautious probably will watch their portfolio crash and burn.

Putting market voodoo aside for the moment, the Standard & Poor’s 500 Index decline between Tuesday and Thursday was its largest since July 1. Federal Reserve chairman Ben Bernanke recently described the economic outlook as “unusually uncertain,” and this week when the Fed decided to directly stimulate the economy for the first time in a year, it gave as a reason that growth “is likely to be more modest” than previously forecast.

These aren’t exactly the type of comments that one would describe as fanning the flames of market paranoia, but they could add a little hot air to the zeppelin’s ride.


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