As the market trades to new all-time highs market pundits are all trying to predict the top and the start of the next stock market crash. This drive to be the first to make this call is partly for egoistic reasons, but also to profit from the decline or to protect gains. “Hindsight is 20/20” - to accurately call a major market top is a daunting task, but to call the next stock market crash is nearly impossible for most investors/traders. Nonetheless, some have claimed the Hindenburg Omen is a handful of technical indicators that have proven to be reliable in identifying major market crashes before they occur.
A famous German airship known as the Hindenburg burst into flames while attempting to land in 1937. The diaster received worldwide press and media coverage and this incident became one of history's most prevalent images of a disaster. Thanks to a mathematician by the name of Jim Mikeka, this disaster now shares its name with a technical tool that was developed to help traders and investors predict and most importantly, avoid a potential stock market crash.
The Hindenburg Omen is a technical indicator that is based on market breadth and looks for statistical deviations from normal market conditions. This abnormal market condition when it occurs is a harbinger of impending danger for a stock market crash. The main criteria that fulfill the Hindenburg Omen sell signal are:
1. New highs and new lows: The daily number of new 52-week highs and new 52-week lows in a broad stock market index such as the NYSE Composite Index (NYA) must exceed 2.2% (for traders) or 2.8% (for investors) of the overall traded issues. The disparity between the new highs and new lows suggests the lack of conviction of market participants to the future outcome of the stock market.
2. The trend of the stock market (NYA) should also be in an uptrend. A 10-wk moving average or the 50-day moving average and possibly the rate of change (ROC) or regression slope are often utilized to confirm the primary trend.
3. The McClellan Oscillator (MCO) is negative. This popular breadth indicator is an oscillator that is created by taking a 19-day exponential moving average (EMA) and a 39-day EMA of the difference between the number of advancing and declining issues. After subtracting the two EMAs from each other, a negative reading signals that the new lows have been increasing faster than it has in the past. This typically warns the trader/investor that the bears are taking control of the market.
When all 3 criteria are satisfied, the Hindenburg Omen is active or triggered for 30 trading days. Additional signals during that period should be ignored. The Hindenburg Omen is confirmed if the McClellan Oscillator (MCO) is negative during the 30-day window and rejected if the MCO turns positive. When a cluster of Hindenburg Omen sell signals (i.e., two or more) occurred within 30 days this even more worrisome.
The Omen has appeared before many of the major stock market crashes, or panic events, in the past few decades hence the active interests by many experienced and astute investors. Although this indicator does not provide frequent signals, one needs to respect the ominous sign when it does occur. Given the inherent upward bias built into the stock markets, any occurrence that is considered to be out of the normal may be a warning of an impending change in investor psychology. Since investment sentiments and herding/crowd psychology are important factors leading to speculative bull market rallies and precipitous bear market declines the Hindenburg Omen can be an excellent indicator to help increase the probability of spotting the next stock market crash before it happens.
Enclosed below is the near-term chart of the Hindenburg Omen. Also, summarized below is the status of the above criteria that needs to occur to generate the sell signal:
1. Is the stock market’s breadth split?
No, not yet. There are currently over 3,100 issues on the NYSE Composite Index (NYA). The number that will satisfy the 2.2% criteria of the total issues traded on NYA is around 68 NYA stocks. As of 8/27/20, there are currently 101 NYA stocks trading at 52-wk highs and only 12 stocks trading at 52-wk lows. The new 52-wk highs have met the criteria but the 52-wk lows did not fulfill the criteria that both 52-wk highs and 52-wk lows need to be greater than 2.2.% of the total NYA tradeable issues.
2. Is the stock market in an uptrend?
Yes. Based on the 50-day ma as well as the 50-period regression trend (slope) to determine the primary trend both indicators are confirming a bullish uptrend in NYA. So, this fulfills the trend aspect to confirm the Hindenburg Omen.
3. Is McClellan Oscillator (MCO) negative?
Yes, MCO has slipped into negative territory (-29.41) over the past week or so. If MCO remains in negative territory for a period of 30-days then this will validate market breadth is weakening criteria.
In conclusion, based on the above analysis the Hindenburg Omen signal is close. However, it is still missing the 52-wk lows criteria, and as such, it did not fulfill all of the requirements to confirm an impending major top and the start of the next stock market crash. Some continue to debate the reliability of this indicator. However, there is no such thing as an ideal technical indicator or a Holy Grail indicator that will work 100% of the time. But it is interesting to note that it does have an overall good track record, successfully predicting market declines more often than not including the 2017 market selloff, the Sep 2018 market correction, and the Oct 1987 stock market crash.