Exposing Ideas to the Envelope of Serendipity

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Saturday, August 22, 2009

Hindenburg Omen and TED revisited

I've added a self updating TED Spread chart on the left sidebar. I want to know if this should spike up anytime soon (and I am doubtful it will ). When it does spike it is almost always is a harbinger of really nasty market conditions to come.

I am also going to start monitoring for any sign of a Hindenburg Omen. So far we are rallying without one since March and that helps tell me this is not a fake out rally so far...

Here are my clippings I saved from 2007 on the subject from various sources at the time:

"The rationale behind the indicator is that, under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows -- but not both." When both new highs and new lows are large, "it indicates the market is undergoing a period of extreme divergence -- many stocks establishing new highs and many setting new lows as well. Such divergence is not usually conducive to future rising prices. A healthy market requires some semblance of internal uniformity, and it doesn't matter what direction that uniformity takes. Many new highs and very few lows is obviously bullish, but so is a great many new lows accompanied by few or no new highs. This is the condition that leads to important market bottoms."

Oftentimes equities will rally after a Hindenburg Omen occurs, faking folks out, then the plunge comes on the other side of the hilltop. 1987 is a perfect example of that, as was 2006.

Here are the details of the three Hindenburg Omen observations in 2007:

June 13th, 2007: There were 3,428 NYSE issues traded, with 96 New Highs and 95 New Lows, the common number equal to 2.77 percent of total issues traded, above the minimum requirement of 2.20 percent. The McClellan Oscillator was negative -116.92. The NYSE 10 week moving average was rising.

June 21st, 2007: There were 3,434 NYSE issues traded, with 106 New Highs and 75 New Lows, the lesser number equal to 2.18 percent of total issues traded, essentially 2.20 percent. The McClellan Oscillator was negative -36.65. The NYSE 10 week moving average was rising.

June 22nd, 2007: There were 3,422 NYSE issues traded, with 88 New Highs and 73 New Lows, the lesser number equal to 2.13 percent of total issues traded, essentially 2.20 percent. The McClellan Oscillator was negative -116.59. The NYSE 10 week moving average was rising.

What does it mean for traders and investors when we get a confirmed Hindenburg Omen? This is really important to understand. A confirmed Hindenburg Omen is not a guarantee of a stock market crash. The odds of a crash after getting a confirmed Hindenburg Omen, based upon the history since 1985, is 25.0 percent. That means the odds we will not have a crash are quite high, at 75.0 percent. It simply means there is a far greater than normal risk of a significant decline occurring within four months of the signal.

You now also have to factor that the Fed is pumping liquidity to prevent crashes once these signals start to occur and certainly the FED has been doing that....

If we are to enter into the next phase and interests rates were to begin climbing, then we will see the market adjust, however, increased rates without any signs of growth coupled with high unemployment will necessitate a period ofdislocations and divergences. Late last week we may have seen the beginnings of such divergences as bonds were rallying hand in hand with the stock market. Something will have to give and it will be important to see those signs in advance.....

Given the rally we are having, I would presume that if we are to drop below March lows then a TED super spike and/or and H.O. should show itself prior. Anyone with historical databases (1929 - 1938) I'd encourage to test for these condition post 1929 crash. I'd love to hear the answer ( although I'm sure it is tough to program! )

Lastly, I neither make the TED nor the H.O. an actionable trade signal. It merely adds "weight" to how I might be looking at the market longer term.

I welcome any commentary on this...

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