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  • j_owley j_owley Aug 13, 2010 6:47 PM Flag

    What do you think of the Hindenburg Omen?

    I read about this on another site. Could we be close to another major stock market crash affecting our RSO?

    So what is a Hindenburg Omen? It is the alignment of several technical factors that measure the underlying condition of the stock market - specifically the NYSE - such that the probability that a stock market crash occurs is higher than normal, and the probability of a severe decline is quite high. This Omen has appeared before all of the stock market crashes of the past 21 years. The way Peter Eliades put it "The rationale behind the indicator is that, under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows - but not both." When both new highs and new lows are large, "it indicates the market is undergoing a period of extreme divergence — many stocks establishing new highs and many setting new lows as well. Such divergence is not usually conducive to future rising prices. A healthy market requires some semblance of internal uniformity, and it doesn't matter what direction that uniformity takes.

    How has this signal performed over the past 21 years, since 1985? The traditional definition of a Hindenburg Omen is that the daily number of NYSE New 52 Week Highs and the Daily number of New 52 Week Lows must both be so high as to have the lesser of the two be greater than 2.2 percent of total NYSE issues traded that day. However, this is just condition number one. The traditional definition had two more filters: That the NYSE 10 Week Moving Average is also Rising (condition # 2), and that the McClellan Oscillator is negative on that same day (condition # 3). These measures are calculated each evening using Wall Street Journal figures for consistency.

    But if we add two more filters, the correlation to subsequent severe stock market declines is remarkable. Condition # 4 requires that New 52 Week NYSE Highs cannot be more than twice New 52 Week Lows, however it is okay for New 52 Week Lows to be more than double New 52 Week Highs. Our research found that there were two incidences where the first three conditions existed, but New Highs were more than double New Lows, and no market decline resulted. There were no instances noted where if 52 Week Highs were more than double New Lows, while the first three conditions were met, that a severe decline followed. So condition # 4 becomes a critical defining component. The fifth condition we found important for high correlation is that for a confirmed Hindenburg Omen, in other words for it to be "official," there must be more than one signal within a 36 day period, i.e., there must be a cluster of Hindenburg Omens (defined as two or more) to substantially increase the probability of a coming stock market plunge.

    So to recap, we have an unconfirmed Hindenburg Omen if the first four conditions are met, but the fifth is not - in other words we only have one signal within a 36 day period. Once a second or more Omen occurs, we then have a confirmed Hindenburg Omen signal with substantially higher odds that a subsequent stock market plunge is coming.

    Our research noted that plunges can occur as soon as the next day, or as far into the future as four months. In either case, the warning is useful. It just means, if you want to play the short side after a confirmed signal, or move out of harms way, you must be prepared to see it happen as soon as the next day, or four months from now, possibly after you forgot about it. About half occurred within 41 days.

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    • A lesson from horse racing:

      If you look backwards, it is easy to point out any number of things co-ocurring with a particular horse wining a given race.

      If you begin to "filter" other races, you can come up with a set of circumstances that occured in a number of races.

      The problem is that today's conditions seldom repeat yesterday's, but you will still win some of the time.

      For example, say your filter was a jockey wearing green silks on a horse favored to win. There are not that many colors, so you would win a lot because your horse was the favorite. Unfortunately, you would not win enough to cover your losses.

      Now think about the overall stock market. How many variables are there and how would anyone be able to weight each variable according to its specific ability to account for any of the variance in stock prices?

      This is one reason why I only trade one stock (RSO). It has one variable that accounts for a huge percentage of the variability in stock price; namely, the dividend.

      There are times when I have little insight into where the price will be; however, there are other times when I am very confident of where the price will be.

      OTOH, the Hindenburg theory will probably go up in flames.

    • tulsadevlin Aug 13, 2010 9:49 PM Flag

      Not sure, but I see a bad moon rising on Aug. 24th. Maybe an omen.


      1) The confluence of data used by the Omen was officially tripped this week

      2) about 25% of Omen appearances have led to stock-market declines that can be considered crashes

      The stock crashes, can occur in as little as one day after the signal or take as long as 3-4 months, but most occur (if they occur) within 41 days.

      My view of things is unchanged. I'm not taking big risks, and I'm already invested in stocks that I'd be willing to hold. I don't see (or know of) any fundamental reason that would justify a "market crash" within the next few weeks. Earnings were good, CSI was up slightly, and unemployment seems stuck at 9.5% (or 25% if you cound underemployment)... I'm not aware of any surprises... We all know this is going to be up-and-down (or sideways) for many months, possibly another 2 years.


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