Over the past few weeks, you may have heard financial pundits and analysts referring to the “Hindenburg Omen.” As you likely know, the ill-fated Hindenburg zeppelin took about half a minute to burn and come crashing to the ground, so it’s clear what this market signal used by technical analysts is supposed to magically foretell. Believers of this market signal suggest that the market is going to crash within the next 30 days.
Wealth Enhancement Advisory Services does not believe this market signal has any actual predictive power in and of itself. Studies that have been done on the validity of this “omen” are plagued with data mining and small sample size issues, both of which undermine any conclusions. Nevertheless, we think it’s important that you understand the basis of what the financial news outlets are discussing.
What exactly is the Hindenburg Omen?
According to believers, this market omen is supposed to be followed by a market crash within approximately 30 days of the trigger. A trigger occurs when the following four events occur on the same day:
- The daily number of NYSE new 52-week highs and lows are both greater than 2.8% of the sum of NYSE issues that advance or decline that day,
- The NYSE index is greater in value than it was 50 trading days ago,
- The McClellan Oscillator is negative, and
- The number of new 52-week highs cannot be more than twice the number of new 52-week lows.
Why should I be skeptical of this so-called omen?
If you are wondering how this seemingly random set of criteria can predict a market crash, it probably can’t. The fact of the matter is, proponents of the Hindenburg Omen that cite its historical reliability tend to ignore some important issues:
- The omen tends to have many false positives. Even though there has been a Hindenburg Omen before every market crash, there have been many Hindenburg Omens that have not been followed by a market crash. You’d miss out on a lot of market upside if you sold after every omen trigger.
- Since there have been only a handful of market crashes in the past century, small sample size bias is a huge issue with the research.
- The existence of the Hindenburg Omen is probably the result of data mining. In other words, researchers dug through piles and piles of data until they finally found a set of criteria that has been true prior to every market crash. But even though the set of criteria has been true, it doesn’t mean the criteria has any actual predictive power.
So what should you do? Keep your wits about you. The media thrives on eye-catching headlines, and it doesn’t get any better than “Hindenburg Omen Predicts Market Crash”. Could the market crash in the next 30 days? Sure, but it could crash over any 30 day period. There is no evidence that the Hindenburg Omen has any true ability to predict a crash. Our goal is to create effectively diversified portfolios that seek to minimize losses were such an event to occur – and seek to deliver higher potential returns if it doesn’t.