What is Smart Money? - World Federation of Young Investors

Smart money consists of the successful hedge funds and big banks that are right about the market directions time after time. Smart money plays with big volume and can in some cases force the market into one direction or another. Smart money is the opposite of dumb money which consists mostly of retail traders and hedge funds that are either trend followers or breakout traders. Smart money buys at the bottoms and sells at the tops and thus outperforms the market with ease.

Source: https://www.skalcapital.com/

As I mentioned before, the retail likes to buy breakouts and sell breakdowns. The problem with buying breakouts in a long-term bull market is that breakouts do not often last too long in the middle parts of a bull market. Breakouts are quickly followed by selloffs which often results in retail selling right at the bottom once their emotions turn bearish again and they see no light at the end of the tunnel.

Retail traders play by their feelings, but smart money goes against retails feelings. When retail traders think the price can never turn back up and they sell their shares in a panic-like event, that is when smart money is buying. In other words, smart money is taking the right positions at exactly the right time whilst retail traders are taking the wrong positions at exactly the wrong time.

You can see this with ease by following investing related news sites and retail traders on Twitter. Whenever there is a selloff in the stock market, the Twitter feed goes nuts from October 1987 type calls and bearish toned news. This was the exact case in early February 2018 when stocks dropped hard in a matter of days. Everyone was calling for a new bear market and what happened? In the next two weeks the tech stock went back to all-time highs. Nothing resembling a bear market…

Source: https://www.skalcapital.com/

News get it wrong time after time.

The news do not lead the market, cycles and sentiment do. News events merely follow the market so that bearish news get the highlight once there is volatility in the market. Here is an example. North Korea shoots a missile over Japan. What does the market do? The market dips briefly intraday but makes new highs the next day. Why is this? Because we were in the advancing phase of a new cycle, which means that price will continue higher.

I talked with a portfolio manager in March about what had happened in early February when the stock market made a sizable drop. He said that everything started from a weaker than average jobs report on Friday and the markets dropped basically because of that. Now think about that for a moment. North Korea shoots missiles and makes nuclear test which could potentially result in war and this guy says that a soft jobs report made the market drop 15%. I say it again. News do not lead the market, cycles and sentiment do. In February 2018, sentiment was overly bullish, and the larger cycle was stretched. This resulted in a correction like it always does. Nothing to do with a soft jobs report.

When you step back from the crowd including your Twitter feed, the news and your colleagues who trade or invest, you realize that these people follow the crowd and follow each other. I highly suggest you should try this out sometime when the next dip in the stock market comes. Keep an eye on the sentiment in your colleagues and your Twitter feed.

95% of traders will never be able to separate their feeling from the game and pull the trigger at the bottoms. They will always pull the trigger when their emotions give by and they feel safe about the trade. Obviously, that is almost exactly when the price turns against them. The name of the game in cycles trading is to try and follow the smart money and avoid following your emotions. If you know that the bottom will be in during the next two weeks, the last thing you want to do is sell or even worse try and short. Rather wait for the bottom to form and buy then.

In order to make consistent profits in trading you need to be one step ahead of everyone else on the market. You need to be in the smart money camp and not the dumb money camp.

 

Sam Laakso

Investment Specialist at LYNX

Main author at SKAL Capital