By: David Goodboy - StreetAuthority
I learned the hard way not to rely purely on technical analysis to make investing decisions.
In the early 1990s, I had built up a decent trading stake by riding the momentum lifting high-tech stocks of the era. Dave, my best friend and the guy who first taught me how to trade, was a die-hard technical analysis proponent who made a small fortune correctly forecasting and buying puts several days prior to the 1987 market crash. He turned his college tuition money into enough capital to trade full time, buy a nice car and not have to worry about working for someone else.
I'll never forget that phone call:
"Dave, the charts have set up just like they did in 1987! It's time to short the market. Within the next week, there is going to be a major crash! It's time to load the boat with puts."
I naively followed his lead and bought as many puts on the SP 100 Index (OEX) as possible. We were both convinced that these puts, bought for around $8 each, would soon be worth hundreds.
After taking the plunge, we met at a local restaurant and talked about all the things we were going to buy with the winnings. I wanted a sports car like he had, and Dave planned on buying a big house with his cash.
I bet you know the end of this story.
The next day, the stock market took off on the upside, rendering our options completely worthless. Nearly all the trading capital I built up over the past several years was gone. My friend ended up moving back in with his parents, disillusioned.
Those hard-learned lessons -- that you should never bet the majority of your capital on any one idea, and that technical analysis is an inexact discipline -- spring to mind whenever I hear a market guru making an extremely bullish or bearish proclamation. If you have been paying attention to the financial news, you have heard the latest bearish proclamation based on the Hindenburg Omen.
What Is The Hindenburg Omen?
With a name more suited for a horror movie than a serious discussion about investing, the moniker is based on the 1937 explosion of the hydrogen-filled passenger airship.
Created in 1993 by mathematician Jim Miekka, this signal uses multiple technical indicators to predict sharp declines in the market. Its primary data point is the number of New York Stock Exchange stocks listed at 52-week highs and lows; each must be greater than 2.8% of the NYSE's total volume traded that day. The theory is that high levels of both new highs and new lows indicate topping markets and sector rotation.
Each signal is said to be valid for 30 days. The indicator has correctly forecast each major market drop since 1987, including the 2008 market rout.
The omen has been triggered twice since May 29. But fortunately, it's accurate only about 25% of the time. While the market has slipped since the omen was triggered May 29, the Dow Jones industrial average (DJIA) is down only about 1% so far after bouncing from the 50-day simple moving average.
Should I Be Concerned About The Hindenburg Omen?
I say the answer to this question is unequivocally no.
While the market may be topping out and could plunge at any time, it's not because of the Hindenburg Omen. Remember, technical analysis is only descriptive of what has happened -- it is of questionable value in predicting what will happen.
Action to Take -- This market is currently being driven by the Federal Reserve's quantitative easing program (QE), not esoteric prediction techniques. All investors should be watching for signs and signals from the Fed that it will start to begin cutting back on its $85 billion in monthly bond purchases. This alone will be a reliable signal that the bull run may soon be over.
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