Hindenburg Omen
A technical indicator that foreshadows an increased probability of a looming stock market crash
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What is the Hindenburg Omen?
Hindenburg Omen, derived from Germany’s Hindenburg airship crash on May 6, 1937, is a technical indicator that foreshadows an increased probability of a looming stock market crash.
The term was coined by James R. Miekka, and it derives its essence from the tragic crash of the airship that once stood as a pillar of hope for aviation, air travel, and the future of humanity. With 36 people killed in the accident, the Hindenburg crash brought upon a wave of sadness and catastrophe, thus resembling the relative nature of the world when a stock market crashes.
Understanding the Hindenburg Omen
Capital markets are fraught with a selection of technical indicators, categorized into the following four buckets:
- Volume indicators
- Volatility indicators
- Momentum indicators
- Trend indicators
The Hindenburg omen – using a combination of the above – is one such bearish indicator that is based on the assumption that stock market declines are preceded by breadth divergences.
A healthy bullish stock market rally is said to abide by the principles of unity – most stocks within a said index are performing well and contributing to the booming stock market. However, breadth divergences occur when the advancing stock market is due to a few big players overshadowing the bearish nature of the rest of the stocks in the index.
The concept is reflected quantitatively through the 52-week highs and lows in an index. When there are many highs and lows in a market, it signals a certain market sentiment, i.e., the market seems to be at a turning point in its rally.
Conditions of the Hindenburg Omen
- Volume: If the number of issues in a specific exchange hits 52-week highs and lows and exceed 2.8% of the total number of issues in the exchange, it acts as what one would call entering the ‘early phase’ of the Hindenburg Omen
- Benchmark index: The benchmark index (an index created to represent the total market including several securities) for the exchange must be greater than its value 50 trading days ago
- McClellan Oscillator: The McClellan Oscillator is a market breadth technical indicator used to evaluate the number of advancing and declining stocks in an exchange. Once the first two conditions are met, the signal is ‘active’ when MCO is negative and vice versa.
Other characteristics that define the Hindenburg Omen:
- The stock market must be rallying, typically measured by the 10-day moving average.
- 52-week highs must not be twice as much as 52-week lows.
Reactions to the Hindenburg Omen
Traders react varyingly to the Hindenburg Omen, but two typical actions following an “active signal” are:
- Shorting the market when MCO is negative
- Refraining from buying stocks / exiting the market when the signal is active due to a negative MCO
Criticisms of the Hindenburg Omen
Despite its accolades and a fool-proof logic, the Hindenburg Omen is said to come with certain caveats. Claimed by some to offer a 25% accuracy, the validity of the Hindenburg Omen remains debatable. Some unfortunate consequences of the indicator are:
- False signals: It is very possible that the stock market remains bullish despite signaling an active Hindenburg Omen, although it’s been mostly accurate for the past 35 years. The consequences of several traders interpreting the omen and preparing for a crash when there isn’t going to be one can be severe and affect several people’s financial livelihoods.
- Skewed data: It is also argued that several non-cap stocks and non-stock exchange-traded funds often skew the data by misinforming the market about its true breadth and volume.
- Outside Effect: Several ETFs within an exchange track foreign stocks and are also found in the NYSE or NASDAQ. If the nature of international stocks is bearish, it may wrongfully misinform investors about the U.S. market despite U.S. stocks being in good condition.
All in all, the Hindenburg Omen is an important technical indicator that’s proven its worth over the years. However, there is always a certain amount of caution that must go into interpreting signals in a stock market, so the Hindenburg Omen is not the only one a trader must rely on.
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