I love this kind of market.

A market where everyone gets so one-sided, we usually get nice moves in the opposite direction.

I know a lot of people have been struggling so far in 2016. I’ve read lots of interesting research on whether the bottom is in, is the top  in, or are we stuck in a range?

The problem with research is that one can always find information to support your thesis. Think confirmation bias. Even supposedly fresh research or new perspectives.

In January I was struggling along with many other traders to stay on the right side of the market.  A lot of the studies and stats I was looking at where so extreme or were showing more ambiguity than usual. That was the first tip off for me.

In late February I was talking with a coaching client, a former portfolio manager at a hedge fund who now only trades his own account.  I generally try to avoid talking too much about the market with clients – we all have our own views. The conversation became very market centered and at one point I declared that I thought that the bottom was in for the year. A potential foot in the mouth moment for me. We’ll see…

At that time my client was mostly flat and was looking to establish positions and was thinking the bottom may not be in, or a least we were due for another significant pullback and that would be his buy opportunity. Like other highly intelligent market participants he had lots of research and stats to back up his thesis.

And that’s the problem in trading. We have to rely on research and stats. But the research and stats don’t tell us what’s actually happening right now, they just tell us what happened in the past.

I think it was Mark Twain who said something to the effect of history does not repeat but it does rhyme.

I’ve had that same conversation with other clients and they’ve all been asking me, how did you know the bottom was in? My answer will probably frustrate some of you, but will make perfect sense to others. It has to do with sentiment, context, and narrative. Three things that most technicians don’t really understand.

When the S&P crossed back up over the 1950 area without looking back, it was sending us a very loud message. Part of that message was the bears were too extreme and the short side was too crowded, and they’re forced to cover.

This is how I see bottoms being formed.  Yes, there typically has to be some type of news catalyst or “driver”, but the reality is it’s buyers and sellers that move price.

I think the smart shorts mostly covered in the mid-1900s – see March 1st. That was stage 1.

Next is stage 2 where the ‘late to the party’ or the weak shorts are forced to cover on the rally caused by the smart shorts booking their profits.

Then, as the weaker shorts get run out of town it starts to attract some early bulls, I call it stage 3.

Although these buyers are typically weak holders, if no new sellers commit at this point, price continues its upward movement simply on the lack of selling and the few remaining shorts throwing in the towel…eventually this happens enough and price goes up enough to attract real buyers. That is stage 4.

Using stages is a simplification of a more complex process, but I think it will help you to think about how “bottoms” are formed.

I think we are well past stage 1, probably a  good ways through stage 2, working on both stage 3  and 4 simultaneously.

The point I’m trying to make is that you can only rely on stats, chart patterns, and other people’s research only so much. In the end, it comes down to sentiment. So far, in 2016 I’m having a very good year after a very rocky start. And the best performing traders I’ve seen YTD  are the ones focusing more on sentiment and less on stats.

The question comes up, how do you  assess sentiment? That’s something I’ve developed for myself and I will tell you that sentiment sans stats cannot really be taught in the traditional sense, but it can be learned. This will make sense to some of you and will not for others. My apologies.

In case you’re wondering, IMO the best tool for analyzing sentiment is you.  You are your own best edge. The process begins by expanding your awareness and learning to tolerate discomfort.

Working on my book and a few special projects involving the development of intuition, I have limited capacity to take on new clients . Therefore, I’m only taking on people who are absolutely committed and a good fit. If you think you’re one, email me first, if you’re still serious, we can have a brief phone/Skype chat to see if it makes sense to work together. I prefer to choose my clients as much as they choose me. You’ll know why once we talk. My self-paced course is another option.

Client quote: “Quality isn’t expensive…its priceless”