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How to Trade: The Hindenburg Omen Stock Market Crash

The tendency of people to turn something like this into a trading system is not a proper usage. It's a warning sign and an investor should never use one piece of information. Take 2007, for example. When you look at the charts along the way up towards the final high in 2007, there were lots of these warnings signs. [There were at least 7 Hindenburg Omen signals on the way up towards the last market crash, according to McClellan data]. Any one of these warnings signs all by itself could arguably be dismissed.

TheStreet: Therefore, the Hindenburg Omen can be dismissed?

McClellan: The Hindenburg Omen has a 30-year history, and the fact of the matter is that we don't get a bear market without one of these signals. You don't get a bear market all the time, but you never see a bear market come as a complete surprise with this signal. To move from bears to canines, think of it this way: every time a dog bares its teeth it doesn't bite you, but it's signaling that it might bite you.

TheStreet: You mention that the Hindenburg Omen had a 30-year history. So what about Hindenburg Omen pre-history? How different was the data before 1980 and how important is that to understanding the data used today to signal the Hindenburg Omen?

McClellan: The primary number being played with in this data set is the number of new highs and new lows and the methodology is the 52-week look-back period. Prior to 1979, there was a different methodology for counting highs and lows. No one had computers. Highs and lows were tracked with pencils, and new highs and lows were calendar year-based. Therefore, the problem is that on Jan. 2 every stock would be hitting a new high or low. The solution was to use the previous year high and low for the first four months of the new year, and then around April, switch to the new calendar year. The look-back period could range from 4 months to 16 months, so any Hindenburg Omen data trying to track its predictive success previous to 1980 is not the same.

TheStreet: How are you trading the markets based on the Hindenburg Omen?

McClellan: I look at so many different pieces of information on a daily basis, and every day there are conflicting indications and it's a matter of which indication to pay attention to on which particular day. At a primary level of market outlook, and given the Hindenburg Omen, my main argument would be that I see lots of liquidity, and that when the level of liquidity is strong it can trump a lot of other indicators. So for the moment, at least, even as we acknowledge bearish signals, it's not time to start worrying about how to make money on the downside.
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