Wednesday, August 18, 2010

The Hindenburg Omen

There was a major blip on most traders radar screens this weekend in that a Hindenburg Omen observation occurred last Thursday, August 12th. The financial blogosphere was lit up with articles and posts about the occurrence, but if you want a detailed account of what I consider to be the best article on the subject, go no further than Robert McHugh's "The Recent Hindenburg Omen Observation" at http://www.safehaven.com/. In order not to poach too much of Mr. McHugh's material, I'll keep my descriptions brief and liberally quote him, so here goes his explanation of what exactly 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 that the probability of a severe decline is quite high."

According to Wikipedia, the criteria for a Hindenburg Omen: "...are calculated daily using Wall Street Journal figures for consistency.". The criteria are: "1)The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows are both greater than 2.2 percent of total NYSE issues traded that day. Based on approximately 3100 NYSE issues, the 2.2% threshold is 69. 2) The NYSE 10 Week moving average is rising. 3) The McClellan Oscillator is negative on the same day. 4) New 52 Week Highs cannot be more than twice the new 52 Week Lows (though new 52 Week Lows may be more than double new highs).".

How high of a probability is there that a crash will happen? First, there has to be more than one Hindenburg Omen occurrence in 36 days for there to be considered a real possibility of a retreat in the market, swiftly or gradually. But if there is, McHugh points out: "there is a 30 percent probability that a stock market crash - the big one - will occur if we get a confirmed (more than one in a cluster) Hindenburg Omen. There is a 40.8 percent probability that at least a panic sell-off will occur. There is a 55.6 percent probability that a sharp decline greater than 8% will occur and there is a 77.8 percent probability that a stock market decline of at least 5% will occur. Only one out of roughly 13 times will this signal fail."

Both The Wall Street Journal and Art Cashin on CNBC had pieces on the Hindenburg Omen this week, so it's not really a far flung notion that a few lunatic fringe traders are drumming up on bulletin boards at the major financial Web sites. As Cashin stated on Monday, "We've never had a heavy sell-off without a Hindenburg Omen, but we've had Hindenburg Omen's without a sell-off.". With this August being a particularly light on volume, even for August when most professional traders are vacationing, it's difficult to tell what will happen, but it does signal caution because market internals are deteriorating. I won't have to keep too close of an eye on this because if we do get a confirmed Hindenburg Omen, it will be all over the financial blogoshpere, not to mentioned the mainstream financial press. This could be another catalyst for the downturn I've been looking for that will surely turbo charge my portfolio.