Be Aware of the Hindenburg

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Be Aware of the Hindenburg

When the German airship Hindenburg caught fire upon landing in 1937, it became one of history’s most iconic images of tragedy. The Hindenburg currently shares its name with a technical instrument developed to assist traders in predicting and avoiding a possible stock market disaster.

This technical signal, known as the Hindenburg omen, may be used to anticipate steep declines and help traders avoid large losses or even benefit from the decline—before others notice it coming—thanks to a clever mathematician called Jim Miekka and his buddy Kennedy Gammage.

There are other indications based on market breadth ideas, but few have received the same attention as the Hindenburg omen due to its capacity to anticipate a future stock market catastrophe. This post will explain how this indicator is calculated and how its numerous indications may help you avoid tragedy.

Market Breadth Theories

The Hindenburg omen’s fundamental notions center from market breadth theories, namely those created by market titans such as Norman Fosback and Gerald Appel. This indicator is calculated by attentively tracking the number of issues on a certain exchange, often the NYSE, that have reached new 52-week highs and lows. Traders seek to obtain insight about a probable fall in the broad market indices by comparing these outcomes to a recognized set of criteria.

The Absolute Breadth Index (ABI) is a prominent market breadth indicator that is used to evaluate market volatility without taking into account price direction.

According to market breadth theories, when markets are rising higher or setting new highs, the number of firms reaching 52-week highs should outnumber the number of companies suffering 52-week lows.

When the market is heading downward or making new lows, the number of businesses trading near the low end of their 52-week ranges should much outweigh those making new highs.

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How the Hindenburg Omen Works

The Hindenburg omen employs the fundamental principles of market breadth by examining the amount of advancing/declining items, but adds a little twist to signal that the market is preparing for a severe downturn.

This indicator signals a warning when more than 2.2% of traded issues make new highs, while another 2.2% or more make new lows. The gap between new highs and lows implies that market participants’ belief is eroding and they are unclear about a security’s future trajectory.

Assume that 156 of the roughly 3,394 traded issues (this figure fluctuates) on the NYSE today set a new 52-week high, while 86 set new yearly lows. Divide the 156 new highs by the total number of issues and you get 4.6%. When we divide 86 (new lows) by 3,394 (total problems), we get 2.53%. Because both numbers are more than 2.2%, the Hindenburg omen has been fulfilled, and technical traders should be on the lookout for a probable market collapse.

Now, the prerequisites for a Hindenburg are only applicable if the ratio of new highs to new lows is more than 2.2%. If the number of new lows in the above example had been 70 rather than 86, the conditions would not have been satisfied since 70 divided by 3,394 is only 2.06%, which is less than the requisite 2.2% to signal a Hindenburg omen.

Confirming a Hindenburg Omen

A signal, like other technical indications, should never be relied on simply to create trades until it is validated by additional sources or indicators. The creators of the Hindenburg omen added a number of additional requirements that must be completed in order to validate and reinforce the conventional warning sign.

The first technique of confirmation is to determine that the NYSE Composite Index’s 10-week moving average is increasing. This is readily accomplished by plotting the index on a weekly chart and overlaying a typical 10-period moving average. The requirement for a possible adjustment is satisfied if the slope of the line is upward.

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When the popular breadth indicator known as the McClellan oscillator has a negative value, the second form of confirmation occurs. This oscillator is constructed by using a 19-day exponential moving average (EMA) and a 39-day EMA of the difference between the number of advancing and declining items. After calculating the two EMAs, they are subtracted from each other, and a negative reading is understood to suggest that the number of new lows has been rising quicker lately than in the past—a warning to traders that the bears are gaining control and that a possible correction is on the way.

Additional Confirmations

Technicians are always striving to improve the precision of a particular signal, and the Hindenburg omen is no exception. Traders have introduced additional confirming requirements, in addition to the ones stated above, in an effort to limit the amount of false signals created.

When the signal is formed, most traders will need that the number of new highs not exceed double the number of new lows. Traders can guarantee that demand for a wide variety of securities is not skewed in favor of the bulls by watching the rising and falling issues. A paucity of securities trading towards the top end of their 52-week ranges represents a lack of demand in the market, and this may be used to confirm the forecast of a downward trend.

Other transaction signals happening in close proximity to the first are the last piece of confirmation that traders will look for. A cluster of Hindenburg omen signals, defined as two or more signals created within a 36-day period, is sometimes considered as much more serious than if just one signal emerges alone. All of the confirmation criteria given in this article are ideas for creating a more accurate forecast of a market collapse, but bear in mind that they may be overlooked if the trader prefers to employ conventional techniques.

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Effectiveness of the Hindenburg Omen

“The omen has emerged before all of the stock market collapses, or panic episodes, in the previous 21 years,” says Robert McHugh, CEO of Main Line Investors, referring to 1985 to 2006. All active traders want a signal that may cause severe market falls, but this signal is not as often as most traders would like. According to McHugh, the omen only produced a signal on 160 occasions, or 3.2% of the approximately 5,000 days investigated.

Although this indicator does not produce regular alerts, it is worthwhile to include it in a trading plan since it may assist traders to avoid a big fall.

The Bottom Line

Every trader wishes they could forecast a stock market fall in order to benefit from it or safeguard some of their hard-earned riches. No indication can forecast these accidents with 100% accuracy. Still, the Hindenburg omen is about as good as it gets in terms of predicting these accidents before they happen.

Traders who use this tool boost their chances of detecting a possible market collapse before it happens, and as a consequence, they may be able to benefit from the drop or preserve their hard-earned riches from being destroyed.

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