The stock market has generated an official confirmed Hindenburg Omen stock market crash warning signal…[for sometime between now and] July 4th, 2021. The last official Hindenburg Omen came January 30th, 2020 and led to a 36.9% stock market crash through March 23rd, 2020…[Indeed,] this Omen has appeared before all stock market crashes, or panic events, of the past 35 years…with crashes after 12 of the 53 completed Omens…22.6% of the time. Will it happen this time round?
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 of a stock market crash occurring is higher than normal, and the probability of a severe decline is quite high…
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. Many new highs and very few lows are obviously bullish, but so are a great many new lows accompanied by few or no new highs. This is the condition that leads to important market bottoms.
…The traditional definition of a Hindenburg Omen was 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% of total NYSE issues traded that day…
- the NYSE 10 Week Moving Average is also Rising, which we consider met if it is higher than the level at any time during the previous 10 weeks and that
- the McClellan Oscillator is negative on that same day…
Critics have taken this Hindenburg Omen definition and pointed rightly to several failed Omens. In other words, with just the above three filters defining a Hindenburg Omen, there were too many false positives to render the indicator useful.
I conducted research convinced that this indicator had strong potential to predict periods of extreme stock market declines, and came up with two more filters (Condition #4 and Condition #50 that…[made] the correlation (the predictive value) of this Hindenburg Omen condition to subsequent severe stock market declines quite remarkable requiring that:
- Condition #4: 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.
- My 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.
- Condition #5:…There must be a cluster of Hindenburg Omens (defined as two or more) to substantially increase the probability of a coming stock market plunge.
- My research noted 12 instances over the past 36 years — using the first four conditions — where there was just one isolated Hindenburg Omen signal over a 36-day period. In 11 of the 12 instances, no sharp declines followed. In only one instance did a sharp subsequent sell-off occur based upon a non-cluster single Omen, but in that case, it was incredibly close to having a cluster of two Omens as the previous day’s McClellan Oscillator just missed being negative by a few points.
- 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.
- We have a confirmed and official Hindenburg Omen signal once a second or more Omen observation occurs…with substantially higher odds that a subsequent stock market plunge is coming.
- My research noted that plunges can occur as soon as the next day, or as far into the future as four months from the date of the last observation within that H.O. event’s cluster. 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.
Based upon the five parameters noted above, here’s what I found: Confirmed Hindenburg Omens are very rare. There have been only 54 confirmed Hindenburg Omen signals over the past 36 years…[and of those] roughly 9,000 trading days only 342 (3.8%) generated one…
If we define a crash as a 15% decline, of the previous 53 confirmed Hindenburg Omen
- 12 (22.6%) were followed by financial system threatening, life-as-we-know-it threatening stock market crashes (I included the Crash of August 2015 which saw a 14.79% plunge from the date of the H.O. observation because the actual drop from the highs just after the H.O. was 15.28%).
- 5 (9.4%) more were followed by stock market selling panics (10% to 14.9% declines).
- 5 more (9.4%) resulted in sharp declines (8% to 9.9% drops).
- 8 (15.1%) were followed by meaningful declines (5% to 7.9%),
- 13 (24.5%) saw mild declines (2.0% to 4.9%), and
- 10 (18.9%) were failures, with subsequent declines of 2.0% or less.
Put another way, there is:
- a 22.6% probability that a stock market crash will occur after we get a confirmed (more than one in a cluster) Hindenburg Omen;
- a 32.0% probability that at least a panic sell-off (a decline greater than 10%) will occur;
- a 41.4% probability that a sharp decline greater than 8.0 % will occur;
- a 56.5% probability that a stock market decline of at least 5% will occur and
- only a 4.3% probability that the signal will fail.
…My research of 53 official H.O.’s since 1985 showed that 33 had 5 or more observations…[and in those instances]:
- the stock market crashed 30.3% of the time afterwards, versus only 22.6% if we considered H.O.’s that had two to four observations. and that is a significant increase in risk and
- the stock market declined by 10% or more 33% of the time vs. 32% if all Omens were considered regardless of the number of observations for each.
As for the current March 4th, Official H.O. signal, it is young, so there is plenty of time for it to increase to a 5 or greater observation H.O. signal. At the very least we can say that the stock market sits in a fragile state at this time, and a black swan event (an unexpected fearful news development) during this period could do significant damage to the stock market.
What does it mean for traders and investors when we get a confirmed Hindenburg
This is really important to understand:
- A confirmed Hindenburg Omen is not a guarantee of a stock market crash.
- The odds of a crash based upon the history since 1985 are 22.6%.
- In the case of more than five H.O. observations, the odds of a crash are 30.3% meaning
- the odds we will not have a crash are quite high, at 78.4% (69.7% if more than 5 observations ultimately occur).
- However… a 22.6% (30.3% if more than five H.O.’s) probability of a stock market crash is extremely high when you consider that there have been only 11 over the past 36 years,
and the normal odds of a crash happening randomly on any day are only about one-tenth
of one percent. You now also have to factor that the Fed is likely to pump liquidity into
markets to prevent crashes once these signals occur.
Given the much higher than normal odds of a crash as related above you may want to think about taking prudent precautionary action such as shorting, increasing cash positions or hitting the sidelines for a while but, even with the heavy liquidity the Fed has been pumping around the time of past signals, the odds of a 5% decline or more remain pretty high at 56.5%..We believe it would be unwise to ignore this potential stock market crash warning.
Editor’s Note: The original article by Robert McHugh Ph.D., has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The authors’ views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technical indicator index.com. The statements, opinions, buy and sell signals, and analyses presented above are provided as a general information and education service only. Opinions, estimates, buy and sell signals, and probabilities expressed above constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this article is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided. Copyright 2021, Main Line Investors, Inc. All Rights Reserved.
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There are two market warning signs which have just recently been triggered and which have gotten a lot of press attention due to their catchy names – the Titanic Syndrome and the Hindenburg Omen – both of which are giving a “preliminary sell signal” based on analyses of 52-week New Lows (NL) in relation to New Highs (NH) on the NYSE within a specific period of time.
The probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen was 77% [conversely, 23% of the time no significant market downturn occurred] and usually took place within the next forty-days. The probability of a panic sellout was 41% and the probability of a major stock market crash was 24%. The Omen was activated on the New York Stock Exchange on August 11 so the probability is that we will see a steep market decline sometime in September. Words: 871
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