What is Smart Money?
Smart money refers to the capital that institutional investors, central banks, and other professionals or financial institutions control. It is controlled by expert investors who can foresee market trends and make most of the profits. Smart money gets its name originally from the concept of gambling, where gamblers 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 or staked by investors who are well-informed or experienced or are both. It is perceived that the money is traded by investors with a complete understanding or information about the market, which regular investors do not have access to.
Hence, smart money is believed to have a greater chance of success when institutional investors have trading patterns that deviate from those of retail investors. Smart money can also move markets when it is controlled by central banks. It then becomes a joint force of large amounts of money where the 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 the cash that is invested or staked by institutional investors, who are well-informed and/or experienced.
- Institutional investors spend the trading day evaluating the price action of the market; hence, smart money is traded during the last hour of every trading day.
Identification of Smart Money
The following sources can be used to identify smart money actions:
1. Trading volume
A more than usual trading volume can be an indication of smart money. It can be identified when the trading volume is unusually high, especially at times when insignificant public data is available to validate the volume.
2. Stock pricing
The information on smart money can be generated by more informed investors in the form of index options and stock pricing. The information is complex for less informed and inexperienced investors; hence, it is used as a source of information by experienced and informed investors.
Thus, knowing the holders of smart money and the securities that they are trading would benefit retail investors who can ride on the success of institutional investors.
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 placed themselves in the market. However, it should be noted that investing action alone cannot always convey the intent of the 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 at the last hour of every trading day.
On the contrary, dumb money is traded at the start of the trading day since they will be reacting 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 case the asset price goes down while the smart money index moves upwards, it usually indicates that the price can move higher.
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