An obscure technical market indicator with an ominous sounding name briefly captured the attention of markets this week. The Hindenburg Omen is a technical indicator that is supposed to foretell the collapse of the American market. The very fact that this was picked up on points the way to important market behaviors. When people are ready to grasp at any straw of negative news it shows a profound weakness in the market.

The Hindenburg Omen reveals a great deal about the behavior of market participants. The indicator is named after the Hindenburg airship which burst into flames in America on May 6, 1937. Just exactly how the name is related to the market conditions it describes is a bit of a mystery. But it's a good sounding name if you are ready to talk doom and gloom.

The indicator is created by monitoring the number of stocks on the New York Stock Exchange making new 52-week highs relative to the number of stocks making new 52-week lows. The omen is confirmed when both numbers are greater than 2.2 percent.

It's always important to distinguish between something that may be statistically significant and something that is of trading significance. The market provides a field of rich pickings for obtuse statistical relationships. There is always a danger of confusing coincidence with correlation. And correlations do not always have any significance in terms of prediction.

The Hindenburg Omen is index-specific to the NYSE with seemingly exact requirements - 2.2 percent. Exactitude creates an illusion of reliability in a world of probability and has great emotional appeal. Why not 2.3 percent? This type of exactitude is often a result of statistical curve fitting and this signals caution. It's what we call a prima donna indicator rather than a robust analysis tool. Prima donna indicators only perform under very specific circumstances. Robust analysis tools provide reliable results under a variety of conditions and in a variety of markets.

There is disagreement among analysts about the current occurrence of this indicator. Some say yes based on their data, others say no based on their data. This is always a warning sign for an indicator that is hedged with exactitude. It suggests widespread curve fitting that is entirely dependent upon an exact data set. In a broader sense many analysts think this indicator is too index-specific to be particularly useful. There is little evidence that the methodology can be successfully transferred to other indexes and this puts this firmly in the camp of coincidence rather than correlation.

There are a number of other patterns such as head and shoulder reversals and more robust momentum indicators that point to the same conclusion in a variety of markets. These confirming signals in the S&P, Dow and Nasdaq are a more robust analysis technique.

This is not to dismiss the indicator but, like all good technical analysis, the signals from one indicator should be verified using signals from another indicator that measures the same events in a different way. A trend breakout is captured with a moving average crossover and verified with a move above the trend line. The moving average and the trend line use different analysis techniques and are independent confirming indicators for the analyst.

Investors don't need to worry too much about the omen. They shouldn't be reacting just to this ominous sounding sign alone. Investors remain cautious. Traders have enjoyed the rally from 10,100 to above 10600 but many used protective stops based on the uptrend line or the support level at 10600. Trend line stop-selling helped accelerate the August 11 fall. This remains an uncertain market and a continuation of the bearish retreat has the potential to trigger a wave of selling. This will allow Hindenburg analysts to claim correlation when end-of-trend signals have been delivered earlier with more robust indicators.

The author is a well-known international financial technical analysis expert

(China Daily 08/23/2010 page14)