Beware the Hindenburg Omen: 3 ETFs to Combat a Market Crash

The Hindenburg Omen is a technical indicator named after the famous German airship that crashed and burned on landing in New Jersey in May, 1937. The indicator’s purpose is to predict potential stock market crashes, and this week, numerous financial blogs are reporting that 4 Hindenburg Omen trading signals occurred on 6/6, 6/16, 6/17 and 6/18.

A “cluster” of Hindenburg Omen signals is generally regarded as being more accurate than one standing alone, and the last cluster of 3 signals in a row was in November, 2007. Market action following that cluster showed a 5% drop of the Dow in just four trading days and a 9% drop by the end of the month.

So, what’s this all about, and should we be worried?

The Hindenburg Omen measures market breadth and overall strength by monitoring the number of securities that reach new 52 week highs compared to those that reach new 52 week lows; when more than 2.2% of securities create new highs and 2.2% create new lows on any given day, a signal is issued. The divergence of new highs to new lows indicates that uncertainty and confusion are in control of the markets and so a significant downturn could be in the offing.

Other elements required for a confirmed observation are:

• The New York Stock Exchange 10 Week Moving Average must be rising
• The McClellan Oscillator must be negative
• New 52 Week Highs cannot be more than double the number of new 52 Week Lows

According to an article in Wikipedia.com, “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 selloff was 41% and the probability of a major stock market crash was 24%.”

Furthermore, Hindenburg Omens predicted every stock market crash since 1985 and 92% of these confirmed signals preceded declines of up to 5% on the Dow.

So, statistically, the bottom line here would indicate a 92% chance of at least a small decline on the Dow, a more than 75% chance of a greater than 5% decline, and a 65% chance of a panic selloff or crash.

So, what should we do? Of course, there can be no one answer to that question since everyone has their own time horizon, their own tolerance for risk and their own investment strategies and goals.

In my work at Wall Street Sector Selector, our primary market indicator, “The Greed and Fear Index,” is in the “red flags flying” mode, which means that fear is in control of the markets and that we expect further declines ahead.

I’m not a follower of the Hindenburg Omen, but if it’s correct, and if my indicators are correct, we could be facing continued lower prices ahead. Possible defensive strategies for such an environment include raising cash, locking in partial profits, buying put options as portfolio insurance or taking positions in ETFs that move inversely to their underlying indexes.

3 ETFs that move inversely to their underlying indexes are:

• ProShares Short QQQQ (PSQ)
• ProShares Short Russell 2000 (RWM)
• Proshares Short S&P500 (SH)

So whether or not this most recent Hindenburg Omen will prove to be accurate remains to be seen, but with today’s toxic mix of a slowing economy, high energy prices and reemerging inflation, it would only be prudent for investors to be on heightened alert for possible dangers ahead.

Disclosure: none

Comments

[buyitcheap]

There are also double inverse funds that allow you to use less cash for a similar hedge. TWM, SDS, QID for the respective indices.