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Saturday, 21 June 2008

Hindenburg Omen

We got a confirming, second Hindenburg Omen observation Monday, June 16th, so we now have an official Hindenburg Omen potential stock market crash signal on the clock. This means, there is an approximate 25 percent probability that we will see a full blown stock market crash within the next 120 days, taking us into a risk zone through October 2008. This is significant as the odds of getting a stock market crash on any given random day is less than one-tenth of one percent. Further, we can tell you that there has not been a stock market crash over the past 25 years without a confirmed H.O. The odds of a significant stock market decline that is not a crash is higher than 25 percent. For those of you looking for more details, go to our Guest Articles section and read our last article on the H.O. NYSE New 52 week Highs were 80, with New Lows at 78, the lower of the two being 2.40 percent of total issues traded Monday, which were 3,240, above the 2.20 percent threshold. The first of these two observations was June 6th. This is the first confirmed H.O. since October 2007, which led to a mini-crash.

Looking back at historical data, the probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen within the next 41 days after its occurrence was 77%, the probability of a panic sellout was 41% and the probability of a major stock market crash was 24%. The occurrence of a confirmed Hindenburg Omen does not necessarily mean that the stock market will go down, although every NYSE crash since 1985 has been preceded by a Hindenburg Omen.

Because of the very specific and seemingly random nature of the Hindenburg Omen criteria, it is possible that this phenomenon is simply a case of overfitting. That is, if one backtests through a large data set and tries enough different variables, eventually correlations are bound to be found that don't really have any predictive significance.

However, the fact remains that out of the previous 25 confirmed signals only 8% (two) have failed to predict at least a mild (2-4.9%) decline.

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