The Hindenburg Omen

The Hindenburg Omen is not a new conspiracy thriller by Robert Ludlum, the master of the three word title. It is a technical indicator that has lately been in the news. Some believe the omen cause the most recent drop in the stock market.

Technical analysis is a method of predicting the movement of stock prices by studying past market data including opening prices, closing prices, daily highs and lows, market volume, as well as historical averages and derivatives calculated from this data using various mathematical formulas.

There is a great deal of controversy over the efficacy of technical analysis. The proponents believe that without even knowing the name of the stock they can predict the future by studying the past performance of those shares. Studies have indicated these claims are at best a bit far fetched. Practitioners of technical analysis sometimes called elves, counter that their predictions are statistical in nature. A particular indicator might work 70% of the time, enough to be effective but not perfect. Elves have been given “stock” charts generated by coin flipping graduate students of academic proponents of the random walk hypothesis. The elves happily give buy, sell, and hold orders based on nothing but coin flips.

I try to be objective. I view most elves in the same light as I view astrologers. However, some of them win often enough that perhaps playing poker might be a more charitable analogy. Three queens over two tens might win most of the time, but that guy across the table is betting pretty heavy. What to do?

I need to add that if a large number of people believe in astrology and will most likely act on a particular planetary alignment, I would be a fool not to at least be aware of such things. I watch 50 and 200 day moving averages and Bollinger Bands, a mathematical method of placing a stock price within 2 standard deviations of its expected movement adjusted for different time periods. A Golden Cross occurs when the 50 day moving average goes over the 200 day moving average. Good juju. The Death Cross occurs when the 50 day moving average drops below the 200 day moving average. Bad juju. These indicators do not make my investment decisions, but they might cause me to delay the purchase of a particular stock. I am pretty good at buying stocks. I am still learning when to sell stocks. My preferred holding period is forever.

So what is The Hindenburg Omen? According to Zero Hedge these conditions must be met.

1)The daily number of New York Stock Exchange new 52-week highs and the daily number of new 52-week new lows must both be greater than 2.2% of total NYSE issues traded that day.
2)The smaller of these numbers is greater than or equal to 69 (68.772 is 2.2% of 3,126). This is not a rule, but more like a checksum. This condition is a function of the 2.2% of the total issues.
3)The NYSE 10-week moving average is rising.
4)The McClellan Oscillator is negative on that same day.
5)The new 52-week highs cannot be more than twice the new 52-week lows (however, it's fine for new 52-week lows to be more than double new 52-week highs). This condition is absolutely mandatory.

Sometimes the Hindenburg Omen works. Sometimes it does not. Maybe it predicts at least a 2% drop in the market something like 75% of the time. Claims and conditions used vary somewhat from analyst to analyst.

Wikipedia concludes, “Because of the specific and seemingly random nature of the Hindenburg Omen criteria, the phenomenon may be simply a case of overfitting. That is, by backtesting through a large data set with many different variables, correlations can be found that do not really have predictive significance. The Omen is at best an imperfect technical indicator that is a work in progress.”

Hmmm…

If you have the mind of a Ph.D. statistician, the self discipline of a German soldier at the siege of Stalingrad, and ice water flowing through your veins, technical analysis might be for you. Technical Analysis for Dummies by Barbara Rockefeller is a good place to start. The author is a well regarded expert in the field. Her writing style is entertaining and easy to understand. The book also contains a very good bibliography for further study.

For Heaven’s sake, Let’s be careful out there today.