So the news over the last few days has been awash with “swine flu”.  As serious as it may be, the story started hitting the wires towards the end of last week and the media had a field day building it up over the weekend.

So guess what, on Monday morning Hogs open limit down!  They did trade off limit briefly during the day, allowing trapped longs to liquidate positions at a horrible price, before closing limit down.

This is a great example of how fickle markets can be.  No one wants Hogs all of a sudden.  Yet according to the World Health Organisation this current flu virus contains components of flu from humans and birds as well as pigs.  Even more incredible is the fact that, to date, not a single pig has died from it!  The market is reacting to the name, not the facts.  This is because the market is made up of humans and humans are illogical creatures.  This demonstrates why investment based upon “valuation models” can be so dangerous.

This is a market we have been watching for the last few weeks, since long before swine flu came into vogue.  Here’s why…

This is a market in equilibrium, with price having oscillated around 73 for the last 3 months and passing through that equilibrium price dozens of times.

A market in equilibrium is like a compressed spring, just waiting to be catapulted in one direction under the influence of an impulse, which is the phase in the cycle that follows equilibrium.  As we noted last week in the S&P, which also remains in equilibrium so far, there is no way of knowing which way the impulse will be – up or down.  Most of the time the reason for the impulse does not become known until weeks after the event, by which time the move is over.

Gapping limit down is the ultimate form of impulse and now we would expect a trend to develop out of this.  So the market is telling us to expect lower Hog prices.  Sadly the huge gap down took away our opportunity to short this market for now as price is too low to meet our risk/reward requirements.  Also as mentioned in last week’s S&P article, when the impulse finally arrives, rarely does the market hang around waiting for you to get a good entry price and you just have to be brave and pull the trigger.  In this case, with the gap, even that option was taken away from us.

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Follow Up: A week later we see nice follow through as expected.  Its just a shame that the gap stole our choice entry point.  But that’s life and there is always another bus coming and its far better to pass on a trade than to compromise your risk/reward rules.