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Sunday, August 8, 2010

The Hindenburg Omen, updated

What is it?

It is a set of conditions, and rules that when all are met, greatly increases the odds of a large sell-off, or crash of the markets. In fact no crashes in the last 22 years have happened, that did not first have a confirmed signal of a Hindenburg Omen. Just because all the conditions have been might, and it becomes a confirmed Hindenburg Omen does not guarantee a crash, only greatly increases the chances of a severe market correction ahead. Another way to think about it is without a confirmed Hindenburg Omen in place, Bulls can sleep a little better at night knowing that most likely they will not awaken to the market down 10%. In fact the odds of a crash based upon the history since 1985 is 27% chance after two or more signals were confirmed.

The best way to think about it is under normal conditions, there can be large number of stocks, setting new 52 week highs, or a large number setting 52 week lows, but not both. Things become out of balance when large numbers of stocks are setting new highs, and lows at the same time. Having one sector soaring, and another setting new lows is not good in the balance of a healthy market.

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.

And that has been updated to include two more sets of conditions to filter out false readings;

1-That the daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 2.2 percent of total NYSE issues traded that day.

2-That the smaller of these numbers is greater than 75. (this is not a rule but a function of the 2.2% of the total issues)

3-That the NYSE 10 Week moving average is rising.

4-That the McClellan Oscillator is negative on that same day.

5-That new 52 Week Highs cannot be more than twice the new 52 Week Lows (however it is fine for new 52 Week Lows to be more than double new 52 Week Highs). This condition is absolutely mandatory.

Rules 1 and 2, are pretty much addressing the same criteria, because if you have 75 issues making new highs/lows, then mathematically, you also have achieved 2.2%. The numbers of issues fluctuates daily and it is quicker to use rule number 2. In other words, if condition 2 has been met, then condition 1 will be met by default.

So, now that you have all five conditions met, now what?

You have an unconfirmed Hindenburg Omen, In order to have a CONFIRMED Hindenburg Omen you must have more then one unconfirmed Hindenburg Omen, or signal, in a 36 day or less period.

Another interesting observation is that once you get two confirmed Hindenburg Omens in a 36 day period , the probability of a severe decline does not seem to increase as more Omens occur, it is possible to have multiple Omens before a crash happens. Multiple signals are telling us things are not getting better, that something continues to be out of balance in the markets.

McHugh's research noted that plunges can occur as soon as the next day, or as far into the future as four months.

So where are we at now?

This is the 10 week moving average on the NYSE composite index. Currently it is rising, and fulfills requirement #3. This is a given and will continue rising for sometime, even with a sell-off it will be slow to start turning down.
This is the McClellan Oscillator, currently it is in positive territory at 25.52, above the requirement of #4. This is an indicator that needs to be check daily as it fluctuates back and forth weekly

This is the NYSE new 52 week highs, this also is a given for now, and will stay above 75 until we see some more downside. Currently reading 185 new 52 week highs after the close today, so it fills the requirement of its role in rule number 1 that new 52 week highs must be above 75.

And this is the NYSE new 52 week lows, I saved it for last because we are not near a point, without some selling pressure to worry about this one fulfilling its requirement for rules number 1 and 2. After the close today, there were 28 new 52 week lows, below the requirement of 75+, but is rising even though the SPX has been rallying, this is what happens when the market is out of balance.

So we have rules number 1 and 2, waiting for more new 52 week lows to be made. This will require a sell-off of a portion, or sector of the index to start throwing it out of balance, something that is happening now, as the 52 week lows are rising. Nothing that will happen over night.
Rule number 3, the 10 week MA is satisfied, and will stay there for awhile.
Rule number 4 needs to be checked daily, but one should not concern themselves until we start seeing more 52 week lows.
Rule number 5, can not even kick in until rules number 1 and 2 are satisfied.

Conclusion- Monday morning the stock market will not crash according to the Hindenburg Omen, we will need a small bleed-off to seeing an increase in the 52 week lows and to get the McClellan Oscillator below the "zero" line. The best thing to do for now is to keep your eyes on the weaker sectors.
As the new 52 week lows approach that 75 level I am sure it will fill the blogs with chat, and most will be aware of an approaching Hindenburg Omen before it gets confirmed. So you can sleep well for now, hehe!!
So now you know a little about what the Hindenburg Omen is, and can track it for yourself!!


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