Last month the nearby hog contract signaled a major change in direction. Following a major sell-off in 2008, the nearby futures consolidated in a volatile 600-point range for a couple months, while unprofitable operations caused massive liquidation of herds by producers. Professional traders started to build long positions in anticipation that prices would rally as liquidating supplies would fall short of demand. This was working well as weekly charts started to depict a major low by taking out the symmetrical triangle (see “Repeating patterns”).
Then H1N1 (Swine Flu) hit and the bottom fell out. Prices declined 850 points in 72 hours. This decline liquidated long speculative traders. In the end, the market is left with reduced ownership in cash and futures contracts. Thus as demand begins to resurface, these buyers will likely want to get back in. The nearby futures should hold the 56¢ level and a sustainable rally can be expected into the summer. It is not atypical for symmetrical triangles to break out, then retrace to either the break-out point or towards the middle of the triangle. The chart shows this happened in lean hogs in 2005 and is close to repeating the pattern. This action gives the trader a chance to establish positions and to do so with less risk as the market establishes support.
Based on the weekly chart, a three-phase strategy may work best. The first phase is to sell July puts for approximately 200 points; then as the daily chart enters an oversold condition using a 6- to 9-period RSI or a reversal indicator, enter a short put/long call (synthetic long futures) position. Finally, as the daily chart begins to show signs of an established bull trend (based on MACD or a simple moving average), buy futures.
Although volatility can create more risk, ultimately these big markets can be caught by having a technical plan on how to attack the market. Volatility will allow for big returns without excessive risk. Phasing into a position and waiting for the charts to confirm the next phase of the strategy can help.
Bill Biedermann is senior vice president of Allendale Inc. in McHenry, Illinois. Reach him via the Web site www.allendale-inc.com .