If you think back to bygone days of wild boar hunting, the hunters would chase down the boars on horseback in hopes of spearing them with a lance or spike. It was this activity that led to the two famous lines, "bleeding like a stuck pig" and "squealing like a stuck pig".
I couldn't help but think of the latter when looking at the June lean hog weekly chart, and putting myself in the position of those who have recently bought thinking the rally should continue. One day into the new week and the possible spike high looks like it could be lethal.
To begin with, take a close look at last week's activity. Though it is hard to see at a distance, the chart shows a gap between last week's low ($128.85) and the previous week's high ($128.375). Turning to Murphy's classic "Technical Analysis of the Futures Markets", page 130 starts the discussion on V Formations of Spikes.
The first precondition for a spike reversal is "a steep or runaway trend." A look at the weekly chart shows this clearly, starting with the low of $87.025 from the week of March 18, 2013. The second precondition is the establishment of a key reversal day, or an island reversal pattern. While a key reversal was not established, the fact that a price gap emerged last week leaves open the possibility of an island reversal. This won't happen this week, unless Friday's close is near the weekly low and next week starts with a sharply lower open.
Murphy also points out (pg. 133) that "the subsequent decline usually retraces a significant portion of the prior uptrend (as much as a third to 50%) in a very short period of time." This fits with my theory that the commercial outlook, known to us through futures spreads, set the tone for how far a market may retrace. A market with bullish spreads may see a minimum retracement of 33% to a maximum of 50%. In the case of lean hogs, the June contract continues to hold a premium of about $2.90 over the August contract.
But take a look at the trend in this spread (bottom study). Notice that there has been a sharp decrease in recent week's following back from the high of $5.30 (weekly close only) the week of March 10, 2014. Comparing to the five-year range, the spread remains bullish, just not as bullish as it recently was. This commercial outlook would imply that the market should retrace 33% to 50%, putting the possible target between $117.975 and $110.225.
But what if the spread continues to weaken and noncommercial traders increase their pace of long-liquidation (third study, blue histogram)? If we look for price support at previous highs we see there is a pocket of trade from late October 2013 through late January 2014 capped near the $102.425 level. Note that this is almost spot on with the 67% retracement level of the previous uptrend. Therefore, it is easy to picture a situation, particularly since we are discussing the always overly dramatic hog market, where the June contract falls all the way back to this bottom level of support.
Weekly stochastics (second study) also suggest that the secondary (intermediate-term) trend has turned down. Last week, after the new high of $133.425 was posted, this weekly momentum study established a bearish crossover with the faster moving blue line (94.3%) moving below the slower moving red line (95.7%) and both still well above the overbought level of 80%. This signal, in conjunction with the developing spike high on the weekly price chart, signal that hog market bulls could soon be squealing.
To track my thoughts on the markets throughout the day, follow me on Twitter: www.twitter.com\Darin Newsom
Commodity trading is very complicated and the risk of loss is substantial. The author does not engage in any commodity trading activity for his own account or for others. The information provided is general, and is NOT a substitute for your own independent business judgment or the advice of a registered Commodity Trading Adviser.