The Hindenburg Omen is an indicator which is believed to forecast market crashes. Unfortunately it does not work, but the idea behind this indicator is worth to be discussed.
Market Breadth – Hindenburg Omen
The Hindenburg Omen is a market breadth indicator. It describes how correlated stocks are within a market behave.
I already had a market breadth indicator in this blog a long time ago, the percentage of stocks within a market above the 200 day average. The Hindenburg Omen does not use moving averages, it is based on the number of new highs and lows in the market.
Hindenburg Omen: idea and calculation
To get a warning signal for an upcoming stock market crash the Hindenburg Omen indicator observes the number of stocks making new 54 week highs and the number of stocks making 54 week lows. In a strong bull market you will usually see a lot of new highs but hardly any new lows, in a bear market you will see new lows, but no new highs.
The ingenious idea behind the Hindenburg Omen indicator is, that a bull market will disintegrate before it is over. This means, that not all stocks will rise with the general tide, some will already start to fall while some others are still rising. So to get a warning signal that the current bull market is over (and a crash might come), you will have to see some stocks with new highs and some stocks with new 54 week lows.
Originally the indicator has been calculated on all stocks on the NYSE. And the original writings suggest that at one given time at least 2.8% of all stocks make new highs and 2.8% of all stocks make new lows. Up to 3 additional rules have been formulated to make it a valid warning sign, but this most probably is just curve fitting to historic events and would not work in the future. But the original idea of a market with new highs and new lows at the same time is worth remembering.
The Hindenburg Omen Indicator
The chart above gives my interpretation of the Hindenburg Omen Indicator for the Tradesignal software suite. It consists of 3 lines:
The red line shows the percentage of stocks within the chosen market which make new 54 week (adjustable) lows. The green line gives the percentage of stocks which make new 54 week highs. The blue histogram gives the actual Hindenburg Omen signal. It starts rising as soon as there are a specific percentage (cut off) of stocks making new highs and other stocks making new lows. As you can see on the left side of the chart (Dow Jones 30 stocks) there has been a strong signal before the 2008 and 2015 correction. On the right side of the chart the Hindenburg Omen indicator is applied to the 500 S&P stocks. Notice the many signals in 2017. These have been a sign of an overheating market, as some stocks already made new lows, although the heavy weighted stocks still drove the market to higher areas.