At the beginning of each AM Meeting I spend some time discussing the bigger picture in the market. Today the focus was on signs that the market may have put in a short term bottom and that I wanted to be mentally prepared for a significant up move. I discussed the downtrend that began in early August up through the buying we had seen the prior two afternoons.

Once I have formed a hypothesis that the market has put in a short term bottom I need to think about what price action I would need to see to either confirm or reject this hypothesis. As I consider various price action scenarios that may unfold in the market I am preparing myself to act in a rationale fashion no matter what the market presents to me. I see myself getting long the market if my hypothesis is confirmed by the price action and possibly short if it is rejected.

We ask each of our trainees to go through this same process. So today when the SPY traded above the pre-market high of 118.90 they were prepared for a move to 120.50 (hopefully). The pre-market high was significant for two reasons. One, the prior three trading days the market had established its high or low for the day in the pre-market. A change in this pattern could lead to an imbalance causing a move to the next major resistance area around 120.50. And two, the pre-market downtrend last Friday began at 119 just above today’s pre-market high.

How would you trade an upside break in the market? You would get long SPY or a few market stocks or a combination of the two. If the market started to move cleanly above 119 you would start to focus mainly on longs showing the most relative strength and consider minimizing short trades.