What is Smart Money?
Smart money refers to the capital that institutional investors, central banks, and other professionals or financial institutions control. It is managed by expert investors who can foresee market trends and make most of the profits. Smart money was originally a gambling term, where it refers to the gamblers that have extensive knowledge of the activity that they wager on or have insider information that the common public is not able to access.
Smart money is the cash that is invested with investing professionals who are better informed or more experienced or both. It is perceived that this money is invested in the right investment vehicle at the right time and will generate the highest returns.
Hence, smart money is believed to have a greater chance of success as institutional investors are believed to have better investment strategies that deviate from those of retail investors. Smart money can also move markets with size and force when it is controlled by central banks. It then becomes a joint force of large amounts of money and good strategy where those investors ride on the success of smart money.
- Smart money refers to the capital that institutional investors, central banks, and other financial institutions or professionals control.
- Smart money is a collective force which has the ability to move markets.
- It is believed that smart money has a better chance of success than retail investors.
Identification of Smart Money
The following sources can be used to identify smart money actions:
1. Trading volume
Smart money may be moving into a position when there is an unusually high l trading volume in a stock, and there has been no industry news or public information to generate the volume.
2. Stock pricing and index options
The information on smart money can be gleaned by more informed investors by analyzing index options and stock pricing. The information from these sources provide an indication of how smart money is positioning its future trades..
Thus, anticipating the positions of smart money and the securities that they are trading would benefit retail investors who can take advanced positions and ride the wave to success.
3. Data sources and methods
Certain methods and data sources are used by data providers to group trading activities into informed and non-informed traders. Analysts use data reports from sources – such as the Commitment of Traders (COT) – to distinguish between non-commercial and commercial trading activities.
Such data sources highlight the difference in the way both groups have positioned themselves in the market. However, it should be noted that investing action alone cannot convey the full intent of these investors.
Smart Money Index
The smart money index is used to understand the performance of smart money in the stock market relative to dumb money, which refers to the money invested by retail investors. Institutional investors spend the trading day evaluating the price action of the market; hence, smart money is traded throughout every hour of every trading day.
On the contrary, dumb money is mostly traded at the start of the trading day as it reacts to the early morning news, overnight news, or economic data.
Uses of Smart Money Index
The smart money index is used by traders in two ways:
1. Confirmation of asset trend
The smart money index does not indicate when to trade in the specific assets; rather, it indicates what an investor can expect from the assets in the short term. For example, if there has been an upward trend of an asset, the smart money index may warn when the trend will change.
2. Variations in the smart money index and the market trends
Investors look for variations in the market trends with respect to the trends indicated by the smart money index. It is called identification of divergence. In the case where an asset price goes down while the smart money index moves upwards, it usually indicates that the price can move higher.
CFI offers the Capital Markets & Securities Analyst (CMSA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: