Last Updated on September 26, 2023 by BFSLTeam BFSLTeam
As a beginner investor, you may have started your investment journey by taking inspiration from your friends, family or colleagues. However, while you may personally know many people who invest in stocks, it’s not only individuals who participate in the markets. In fact, a vast majority of the money in the markets is controlled — not by individuals — but by large institutions. We call them institutional investors, and the funds they put into the markets are collectively called smart money. In this article, get to know more about what smart money is, why it’s important and how you can use smart money trading strategies to your advantage.
Also Read: Positional Trading Strategy
Table of Content
What is Smart Money?
Smart money is the collective capital in the financial markets. It is controlled by institutional investors, market experts, superstar investors, central banks and other market moguls. The funds infused into the markets and controlled by these investors are considered as ‘smart’ money because trades made using these funds have a higher chance of success.
This, in turn, is because institutional and other expert investors in this category collectively control large volumes of capital. As a result, they are not market followers; they are market movers instead. By contrast, the money controlled by retail investors is commonly referred to as herd money. It is considered to be weaker in terms of its ability to move the market.
A Closer Look at How Smart Money Works
Institutional investors have a unique advantage while participating in the financial markets. They have the experience, knowledge and insights to understand and often forecast market trends with a high degree of accuracy. Consequently, they are better placed to initiate trades or exit positions at favourable price points.
This gives the impression that institutional and ace investors have greater success with the trades they make. In other words, from the average retail investor’s perspective, expert investors appear to be more successful at allocating their money to the right assets or stocks. Hence, the name ‘smart’ money.
Identifying Smart Money: Key Indicators to Look Out For
It is important for retail investors to be able to identify when smart money is prevalent in the market. This is because smart money actions can impact stock prices and market trends. The following indicators can help you identify smart money trading in the market.
- Insider Buying
Insiders in a company include board members, directors and other executives who may have access to information that retail investors do not. If you find that insiders are buying equity shares of their companies in large volumes, it could indicate the presence of smart money. You can track large-volume insider trades on most leading mobile trading apps itself.
- Large-Volume Trades
When institutional and other ace investors determine that a company has good growth prospects, they tend to initiate large-volume trades or bulk buys in the firm’s shares. This may also be true for large-volume selloffs in companies with poor prospects. By tracking such high-volume trades, you can evaluate the manner in which smart money is moving in the market.
- Changes in Growth Sectors
Smart money trading is common in sectors with a high potential for growth. Investors with smart money tend to focus greatly on sectors that hold promise for the future. Some examples may include IT, solar energy and healthcare. The same is true for growth stocks too. You can monitor smart money movements in these sectors and stocks to identify emerging trends.
- Index Options
You can also evaluate index options and stock pricing methods to glean more information about where smart money is active in the markets. This will also give you a better idea of how investors with smart money may plan to trade in the near future. Using these crucial details, you can formulate a trading plan that ensures you are ahead of the curve.
- Volatility
High levels of market volatility coupled with large trading volumes may also indicate the presence of smart money. This is due to the fact that retail investors cannot typically create enough volatility to move or reverse market trends. So, keep an eye out for any spikes in market volatility and use this indicator in combination with the others outlined above for confirmation.
Trading Strategies
If you want to incorporate smart money signals in your trading plan, you need some clear-cut techniques to begin with. The following smart money trading strategies may be just what you need.
- Sideways Price Action
When the market is moving sideways, the prices are typically stable. This is when institutional investors with smart money tend to consolidate their positions by buying or selling stocks during such periods of limited volatility. If you choose this smart money trading strategy, remember to factor in the volume for a more comprehensive overview.
- Aggressive Trade Initiation
If the price of a stock has been stable for a while, investors with smart money may initiate aggressive buying action. This is often the case with companies that have good growth prospects. Before the aggressive buying begins, large investors may be building up their positions with smaller trades and then go in for the big buys.
- Swift and Shart Prices Reversals
When the market is strongly trending in one direction, but abruptly reverses direction, smart money could be the reason. For instance, in a falling market where sellers are dominant, if the price suddenly turns around and starts to rise, it indicates that buyers have gained the upper hand. This is typically only possible by institutional investors and market movers who control large amounts of smart money.
Also Read: Swing Trading vs Position Trading
Conclusion
As a retail investor, you may find the term herd money often interchanged with dumb money. While this may sound disagreeable, it does not actually mean that some money is ‘smart’ while a different type of money is ‘dumb.’
The classification of funds in the markets as smart money and herd money was primarily done to differentiate between different classes of investors. Irrespective of the terminology used, you can use the smart money trading strategies outlined in this article to stay ahead of the curve and improve the chances of making profitable trades.
