This is a lesson in how you can trade with confidence.

PRE-OPEN MARKET COMMENTS MONDAY – Opinions are like @$$holes. Everyone has one. People will provide you with a litany of reasons why the market is going to go up or down. Their analysis will include what the Fed is going to do, guesses on economic growth and predictions of future inflation. Outside research breeds confusion and chaos. Learn how to read price action and don’t listen to all of the other fools. Here’s what the market is going to do.

If you don’t trust me, that’s fine. Learn this lesson and watch from the sidelines. Trust is established over time. When my analysis proves to be right, check my track record on YouTube over the last decade. Once you’re convinced that my method works, do everything you can to learn it.

How can I be this confident? Because I don’t listen to what institutions, analysts and fellow traders are saying. I watch what they are doing. You can’t trade if you don’t have confidence. You can’t stick with a position if you don’t have confidence. You can’t add to a position if you don’t have confidence.

There will be times when your confidence is low. During those stretches it is important to be honest with yourself and to trim your size and your trade count. When buyers and sellers are in equilibrium, the market is very choppy and directionless. We need to wait for one side to prevail. Since August, the market dropped 10% and it snapped back. It compressed below the all-time high and it could have gone either way. There’s no shame in admitting that you don’t know where the market is going next. You have to wait for a breakout or a breakdown. Know the price patterns that will get you bullish and know the price patterns that will get you bearish.

Last week the market had a “nasty day” and it pulled back sharply on heavy volume. The compression was breached. That could have been the “tell” that we’ve been waiting for, but it was too early to aggressively short. The market did drop 10% in August, but it bounced right back. The fact that it was able to rally all the way back was a sign that we had to temper our bearishness. This was a sign that buyers were still engaged. If the market only rallied back to the 50-day MA, that would have demonstrated that sellers were aggressively in “risk off” mode. They did not feel that the market would get back to the all-time high so they would have been eager to reduce risk on any bounce. On a meager bounce after a big drop, we could have gotten aggressively bearish in August. Consequently, we had to wait before we could aggressively short. The market was resting above the 50-day MA and a major economic releases (Jobs Report) could have produced a rally that challenged the all-time high or a breakdown below the 50-day MA.

Once the report came out, we had to know the price patterns to watch for. They would tell us which way the market was going to break. The first move was higher and we know that gap reversals could quickly gain momentum. Given the selling pressure earlier in the week and the gap up, this was our best scenario. We were watching for stacked red candles early in the day and a rising VIX/VXX. If the 50-day MA failed easily, we would have the technical confirmation we needed to short. For complete analysis from last Friday, please watch this video.

So now that the market has breached support, where do we go next? The chart is telling us that we are going lower. Don’t think of the candle sticks on the chart as green and red boxes, think of them as a roadmap. They are not telling you what institutions are thinking, they are telling you what institutions are actually doing. In this case we have a 10% market drop that happened a month ago. A drop of that magnitude would not have happened if buyers were super aggressive. They would have been bidding aggressively and the drop would have been a tiny little dip that did not even show up on the chart. That’s not what happened. This was a legitimate drop and it came on heavy volume. The ensuing bounce came on light volume and that tells us that the conviction on the part of buyers is fairly light.

Now we have a lower high double top. That is also significant because it is a sign that sellers were anxious to reduce risk before it challenged the previous high. Bull markets die hard and buyers have been conditioned to buy dips. That’s why we bounced on light volume.

So where do we go next? After a massive drop, we can expect a bounce the next day or two. How can I tell? Just look at previous long red candles that are equal in magnitude to the drop Friday. Buyers will nibble at that low thinking that the move was over-extended. Sellers who are anxious to reduce risk don’t want to chase and they will wait for higher prices. Do we always get a bounce after a long red candle? No. We are traders and we play the odds. Usually we get a bounce and you can see that in the chart below. That means we let it run its course and we look for opportunities to get short.

What do long red candles mean? They tell us that the market opened near the high of the day and it closed near the low of the day. Look at all of the long red candles in the chart above. Bearish markets tend to open on the high and close on the low. We also know that gap reversals are our best trading set up. That gap up gives us plenty of room to the downside and that reversal has the potential to gain momentum. That means you should be favoring the short side this morning. You have the longer term technical confirmation and now you will be looking for M5 technical confirmation.

At very least I expect the market to test the 100-day MA before the FOMC statement (September 18th). How we attack that support level will determine if we test the 200-day MA. If we take out the 100-day MA with ease on heavy volume, we will test the 200-day MA. If the 100-day MA is “sticky”, it will probably hold until the FOMC. There’s little doubt that institutions are selling. Just look at what they are doing!

Don’t listen to ANY analyst and don’t get research from anyone. Learn how to read price action and do your own analysis. This is where confidence comes from and in time you will learn to trust what the price action is telling you.

Look for opportunities on the short side.