Thoughts on the 'Hindenburg Omen' and Market Instability.

There are many interesting 'indicators' of market movements out there ... from the Big Mac Index to the Super Bowl Indicator, and (of course) more common ones like rolling moving averages. 

One of the more supposedly nefarious indicators is the Hindenburg Omen, and the pattern has shown up twice recently.

 

What is it? 

It is a fairly obscure technical analysis pattern, which supposedly gives an early warning of unstable market conditions (and even potentially stock market crashes).

While the calculation is based on five factors, the primary conditions indicate a big disagreement about market conditions.

For example, two of the conditions are that a substantial number of stocks have to be at yearly highs, while a substantial number of stocks have to be at new annual lows.  Ultimately, it is hard for those two conditions to be met in a short period of time unless there's uncertainty in the market.  Moreover, after a rally, uncertainty is often a precursor to a decline.

In addition, technically (for the pattern to be complete), a second sighting of the five elements must occur within 36 days. Logically, lingering uncertainty is a momentum killer. 

Should I Be Worried?

This week, Cumberland Advisors' shared the following from Art Cashin, Director of Floor Operations for UBS Financial Services at the New York Stock Exchange. 

Art had this to say: 

“I had told Carl Quintanilla on CNBC’s Squawk on the Street in an interview about 10:20 that I thought the chatroom bears were turning a bit more aggressive. Several were trying to point out that we had had two Hindenburg Omens in a row. In case you had forgotten, a Hindenburg Omen is rather arcane indicator that takes as a measurement the ratio or relationship between the new 52-week highs and the new 52-week lows. It is quite unusual to have two days back-to-back with new Hindenburg Omens.

Now, you have to be a little bit careful about the Hindenburg Omen because, over the last 35 or 40 years, we haven’t had a market ‘crash’ without the presence of the Hindenburg Omen, and that is what chatroom bears were pushing. You have to remember the other part of that, which is while there has always been a Hindenburg Omen before a crash, there has not been a crash after every Hindenburg Omen. To use a rather poor analogy, it is almost like saying, we have never had a flood without rain. But, then again, every time it rains, it doesn’t mean it is going to flood.

So, it was, nevertheless, an effective tool among the chatroom types just to make people nervous. I am not sure how many have bought into the Hindenburg aspect, but it was one of those ‘Wait a minute – should I be aggressive on the buy-side or should I wait and hold back here?’ I think it had some of that effect.” - Art Cashin

 

From my perspective, while this pattern may have correctly predicted every big stock market swoon of the past two decades (including the October 2008 decline), not every Hindenburg Omen has been followed by a crash. Resorting to a geometry analogy: All rectangles are squares, but not all squares are rectangles.

Times are strange - and there's reason to be wary of the markets, but indicators like this are a reason to be cautious, not a basis for trading decisions.