The Hindenburg Omen… Are you Trading Myths or Facts?

by Steve Palmquist 
Don’t miss Steve and 5 other speakers at the Las Vegas Traders Seminar October 9-10, 2010 

The financial press is full of articles about the ‘Hindenburg Omen’ and how it indicates that the market is about to plunge. The Hindenburg Omen is a combination of new 52 week highs and lows, the NYSE’s 10 week moving average, and the McClellan Oscillator. The creator of the Hindenburg Omen compares it to ‘a funnel cloud that precedes a Tornado’ and says it shows there is ‘a high probability that the market is going to crash’. The images of the actual Hindenburg disaster, and a Tornado, are vivid and scary. This plays well in the media, after all their job is to attract viewers for their advertisers, and a lot of financial shows can be; well, boring.

The key issue for any indicator is not the images it brings to mind, but whether or not it has predicted outcomes more often than chance, and hence is a useful trading tool. According to an article on CNBC the Hindenburg Omen has been ‘roughly 25% accurate in predicting big market upheaval since 1987’. That is another way of saying it has been wrong most of the time. Traders need to carefully understand, test, and evaluate every potential tool before considering using it. New indicators come along all the time. Some sound interesting, but the issue is always, ‘how well has it worked, and based on that should I add it to my trading tool box’. The idea of testing and evaluating a tool before using it is a fundamental part of trading. Even a broken clock is right twice a day, being right occasionally proves nothing. Traders need to break through the myths and select tools that have shown some real promise.

There are hundreds of indicators and patterns being used by traders. Many of them provide no more accuracy in predicting market direction than a coin flip. The bigger issue is that many traders do not even know how often the indicators and patterns they use have shown positive results, and how often they have failed. Not knowing this information is like throwing darts in the dark. Effective traders know what percentage of the time their trading techniques work in bullish markets, trading range markets, and bearish markets. Successful traders have multiple tools designed for different market environments and switch between them based on what the market is actually doing, not what the talking heads on TV say it is doing. Are you trading myths or tested results?

The Stochastic indicator is better known and more widely used than the Hindenburg Omen, but traders need to ask the same question before using it. How often does it work, and based on that data is it a valuable tool for trading? I tested the effectiveness of the Stochastic indicator by looking at trades during 2008 when the stochastic was below 20 and then moved above 20. After entry, each position was held for five days and then sold. During 2008 there were more than 26,000 trades in my trading data base of 2,500 stocks and only 41% of them showed a positive outcome.

2008 was a tough year for stocks, and market conditions can effect most trading systems, so I looked at all the Stochastic buy signals during calendar 2007. There were more than twenty thousand stochastic buy signals during calendar 2007, but only half of them were winning trades and the annualized return of all the trades was negative. I also looked at the sixteen thousand stochastic buy signals that occurred during 2006 and found that about fifty one percent of them were winning trades.

I then looked at how the test results for the Stochastic indicator varied based on different holding times and in different market environments. The results of this testing are covered in ‘How to Take Money from the Markets, Creating profitable Strategies’ This book analyzes six ready to use systems and shows how they work, and when they work. Trading systems are not magic, or based on hope. Effective traders use trading techniques that have been fully tested and analyzed. They know exactly how the systems have performed under different conditions and how different filters and variables effect results. When they pull a tool out of the trading tool box they know what to expect, and how to use the tool. This knowledge comes from testing and evaluation, not hopes and dreams.

Effective traders select trading tools based on the markets current environment, and their results of testing trading tools in different market conditions. They know when to trade pullbacks or retracements, whether they should focus on shallow or deep pullbacks, how trading results may be effected by the volume patterns, if the price of the stock or the average volume of the stock effects results, and several other key stock behaviors that can be tested and then used to improve trading results.  No one is born with this knowledge, it is gained by testing and evaluating the behavior of stock patterns and trading systems. Traders can do this work themselves using many of the popular software packages that allow writing programs to test different patterns and indicators, or they can review the research presented in ‘How to Take Money from the Markets’. Trading without a clear understanding of how the market and several different trading systems work is like driving blind. Blind drivers usually have a bad outcome. Rather than rely on some new indicator with unknown success rates I will focus on techniques that have been tested and shown to have reasonable success rates. The market may indeed take another leg down, if and when it does there are more reliable indications for traders than the Hindenburg Omen.

Steve Palmquist a full time trader who invests his own money in the market every day. He has shared trading techniques and systems at seminars across the country; presented at the Traders Expo, and published articles in Stocks & Commodities, Traders-Journal, The Opening Bell, and Working Money.

Steve Palmquist a full time trader who invests his own money in the market every day. He has shared trading techniques and systems at seminars across the country; presented at the Traders Expo, and published articles in Stocks & Commodities, Traders-Journal, The Opening Bell, and Working Money.

Steve is the author of two trading books:
“Money-Making Candlestick Patterns, Backtested for Proven Results’, in which he shares backtesting research on popular candlestick patterns and shows what actually works, and what does not.

“How to Take Money From the Markets, Creating Profitable Trading Strategies” in which he uses the results of extensive backtesting techniques to smash trading myths and get to the truth of what has worked and what has not. The book provides six fully analyzed and tested trading systems and shows how they have performed in different market conditions.

Steve is the publisher of the, ‘Timely Trades Letter’ in which he shares his market analysis and specific trading setups for stocks and ETFs. To receive a sample of the ‘Timely Trades Letter’ send an email to Steve’s
provides additional trading information and market adaptive trading techniques.

Leave a Reply