Why 'Hindenburg Omen' Is Just a Superstition

Source: Wikipedia

The Hindenburg burning.

An obscure technical market indicator with an ominous sounding name is again capturing the attention of markets. The 'Hindenburg Omen' is a technical indicator which is supposed to foretell the collapse of the American market. The last time it appeared in August 2010 it failed. The market did not collapse. Instead the Dow Jones Industrial Average rose from 10,200 to 12,700, or about 24 percent over the next nine months.

The 'Hindenburg Omen' reveals more about the behavior of market participants than it does about the market. The indicator is named after the Hindenburg airship which burst into flames in America on May 6, 1937. Just exactly how the name is related to market conditions it describes is a bit of a mystery.

The indicator is created by monitoring the number of stocks listed on the New York Stock Exchange that make new 52-week highs relative to the number of stocks making new 52-week lows. The omen is confirmed when both numbers are greater than 2.2 percent.

(Read More: The 'Hindenburg Omen': Bear Signal Scares Market)

It's always important to distinguish between something that may be statistically significant and something that is of significance for investors. There is always a danger of confusing co-incidence with correlation. And correlations do not always have any significance in terms of prediction.

The 'Hindenburg Omen' is index specific to the NYSE with seemingly exact requirements - 2.2 percent. Exactitude creates an illusion of reliability in a world of probability. This type of exactitude is often a result of statistical curve fitting and this signals caution. This is not a robust analysis tool. Specialist indicators only perform under very specific circumstances. Robust analysis tools provide reliable results under a variety of conditions and in a variety of markets.

There is disagreement amongst analysts about the current occurrence of this indicator. Some say yes based on their data, others say no based on their data. This is always a warning sign for an indicator that is supposed to be exact. Many analysts think this indicator is too index specific to be particularly useful. There is little evidence that the methodology can be successfully transferred to other indexes such as the Nasdaq and S&P 500 and this puts this indicator firmly in the camp of co-incidence rather than correlation.

The current technical situation in the Dow, Nasdaq and S&P 500 suggest temporary pullback to nearby support levels after each of these indexes recently reached their projected target resistance levels. This is a retreat within the environment of well established uptrends. There is no other evidence of end of trend behavior.

In 2010 the accuracy of the 'Hindenburg Omen' indicator went up in flames and the current situation suggests the same result in 2013.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

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