Hindenburg Omen signals trouble

Is it another bad sign for the markets -- or just hocus pocus?

By Jamie Dlugosch Aug 16, 2010 4:28PM

It turns out I'm not the only one predicting doom and gloom for the markets in September.


The Wall Street Journal recently reported on the Hindenburg Omen, a technical gauge said to be predictive of a stock market crash.


Developed by a blind mathematician in 1995 and named after the horrific dirigible crash of the early 1900s, the Hindenburg Omen uses a confluence of data including 52-week market highs and lows to predict activity.

The indicator has a 25% success rate in predicting market crashes. We should all be concerned then when the signal flashes red lights, as it did last week.


Will the Hindenburg result in the market bursting into flames this go-around?


I'm not sure, but I'm not waiting around to find out.


On July 28, I posted a blog that suggested investor psychology was little changed despite a summer rally that had markets rising significantly in July.


In the post I suggested that investors would be wise to trim equity positions in advance of a potential decline, with the specific recommendation that investors deploy inverse exchange-traded funds (ETFs) by the middle of August.


I was trimming back my equity exposure to 50% stocks with 25% invested long/short and the remaining 25% invested in inverse ETFs.


What inverse funds did I suggest?


At the top of the list is the ProShares UltraShort Semiconductor Fund (SSG). The semiconductor industry is the leader in a recovery and the first to collapse at the first sign of trouble.


Last week, technology bellwhether Cisco Systems (CSCO) reported earnings. In the report the company noted that it was seeing mixed signals in the market.


The numbers it was releasing became irrelevant. What mattered to the market was the visibility and on that end the conditions were cloudy at best.


Another fund to consider is the ProShares Short Russell 2000 (RWM). Small stocks tend to go up faster in a rising market and fall quicker in a down market. Investors looking for a hedge would do just that with this particular fund.


The other three options I use for protection in a down market are ProShares Ultra Short China Fund (FXP), ProShares Short S&P 500 (SH) and ProShares Short Real Estate (REK).


I would take an equal position in all five of these funds for at least the next month or two.


The Hindenburg Omen may turn out to be nothing at all, but at least you will be protected in case a crash does occur.


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