Should you be worried about a stock market crash in 2013… or even sooner?
Certainly, there's plenty of unsettling news to worry about.
But now, there's one more reason to fasten your seat belt.
On the heels of a sharp stock market decline on July 24, a highly accurate technical indicator called the "Hindenburg Omen" started ringing warning bells.
Ever since it was discovered, this ominous-sounding signal has proven remarkably accurate in gauging the stock market's relative strength or weakness.
In fact, the Hindenburg Omen has nailed every New York Stock Exchange (NYSE) crash since 1985.
Here's what you should know.
The Hindenburg Omen Basics
The famous German airship known as the Hindenburg became one of history's most prominent images of disaster when it burst into flames while attempting to land at Lakehurst, NJ, in 1937.
The doomed airship later became the moniker for a technical tool invented to predict a potential stock market crash.
The underlying concepts of the Hindenburg Omen revolve around market breadth theories created by Norman Fosback, an investment strategist who co-founded The Institute for Econometric Research in 1971.
The theory suggests that when markets are hitting new highs, the number of companies posting 52-week highs should be greater than the number experiencing 52-week lows. Conversely, when the market is creating new lows, the number of companies trading at their 52-week lows should outnumber the companies recording new highs.
There are three technical indicators that, when met, signal a "warning":
- First, the number of NYSE new highs and lows must be higher than 2.8% of the advances plus declines.
- Second, the number of new highs cannot be more than twice the number of new lows.
- And third, the NYSE composite must be above its 50-day moving average.
All these conditions were met on July 24, triggering a Hindenburg Omen warning.
When that happens, a 30-day cautionary period begins.
A second reading within that time period suggests a 77% probability of at least a 5% decline in the following 40 days.
Over and over again, the Hindenburg has proven to be about as good as it gets when it comes to being able to identify crashes before they happen.
Between 1985 and 2006, the omen rang the alarm before every stock market crash or panic event, Robert McHugh, CEO of Main Line Investors, told USA Today.
Even better, this signal doesn't come around all that often. It only created a signal on 160 separate days, or 3.2% of the approximate 5,000 days that he studied.
The signal flashed seven times in 2008, as the S&P 500 posted its biggest annual drop since the Great Depression.
The last time the Hindenburg alarm went off was in August 2011. The Dow Jones Industrial Average then proceeded to plunge 16.2% from its July highs.
Analysts Issue Warnings
The Hindenburg isn't the only reason to believe the market could be in for a reversal.
Robert Prechter, author of Conquer the Crash, warns that today's economy looks eerily like the Great Depression and deflation will cause financial chaos.
Prechter predicts that the major U.S. stock indexes will plunge below their bear market lows hit in March 2009 during the last financial crisis.
"For the third time in a dozen years, the stock market is in a very bearish position," Prechter told USA Today.
If he's right, stocks would lose more than half their value.
Prepare Now for Stock Market Crash 2013
We don't yet have a secondary confirmation of the Hindenburg Omen, so there's still time to get ready for a market tumble.
Shorting stocks or purchasing "put" options on an index is the most obvious strategy.
You can also purchase specialized inverse funds like the ProShares Short Dow30 ETF (NYSEArca: DOG), that actually rises when the big blue chips fall.
Getting ahead of the crowd also allows you to tighten up your trailing stops as a means of protecting hard-earned profits.
Finally, it's a great time to put together a "shopping list" of stocks you want to buy, as they become cheap relative to their intrinsic value.
Money Morning Chief Investment Strategist Keith Fitz-Gerald has strongly encouraged investors to look at "glocal" companies as a way to weather even the worst stock market swoons.
Again, we're not saying you should be market timers. Study after study has shown the dangers of that approach. But the Hindenburg Omen may be suggesting caution is in order, along with a little preparation.
By being opportunistic, you can take steps to preserve your wealth against a stock market crash and capitalize on opportunity when it knocks.
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Hindenburg Omen Stock Market Crash Signal July 24 2012