Smart money is the funds that are under the control of institutional investors, central banks, fund, market mavens, and other financial individuals and entities. The term smart money was basically a wagering term which was referring to the bets placed by the gamblers with a history of success.
Generally, these wagers were immensely knowledgeable about the sport in which they were gambling or had insider information which was not made public.
The world of investments is similar. The common people think of smart money as the investment made by individuals having an in-depth understanding of how markets play and have information that is never known to a normal investor.
Likewise, the smart money is often perceived as having a lot better chances of finding success at a time when the patterns of trading followed by an institutional investor vary from that of a retail investor.
What is Smart Money?
Smart money is capital steered by institutional investors, financial entities, central banks, funds, and other financial professionals. Adept investors who can predict market trends handle it and in turn, yield maximum potential profitability.
The meaning of smart money has evolved. It was originally associated with gambling – players good at betting or in possession of inside information that is publicly unavailable. Similarly, smart money is often perceived as more likely to succeed. After all, institutional investors’ trading patterns differ from that of retail investors
Simply put, smart money means the biggest and smartest player in the game. People who have extensive information and a thorough understanding of the market have an overwhelming influence on the financial markets, so smart money will always win.
Smart money is the collective force of big money that can significantly move the market. In this context, central banks are the driving force behind smart money, and individual traders follow smart money.
How to identify smart money?
Some indicators of smart money include:
- Trading volume: Conventional wisdom holds that informed speculators typically invest more. This implies that smart money may be associated with an unusually high trading volume in a stock, with no justification to the ordinary person.
- Stock pricing and index options: A significant source of information is generated largely by informed market participants is pricing and indices. Such information can be complex and confusing to untrained investors. Therefore, it serves and is used by an informed set of market participants. Knowing smart money owners and where they invest can benefit retail investors.
- Data sources and methods: Data providers use various methods and sources to collate transaction data from commercial and retail traders. Analysts use such data reports – from sources like the Commitment of Traders (COT) – to distinguish between non-commercial and commercial trading activities.These data sources highlight the differences in how the two groups position themselves in the market. However, it is worth noting that investment actions do not fully communicate the intentions of these investors.
Smart money index
Money invested by retail investors is sometimes referred to as dumb money. The Smart Money Index is used in the stock market to understand the performance of smart money as opposed to dumb money. Institutional investors spend the trading day evaluating price movements in the market. As a result, smart money is traded every hour of every trading day. In contrast, dumb money mostly trades earlier since it reacts to the morning news, overnight news, or economic data.
Uses of smart money index
Traders leverage the smart money index in two ways:
- Confirmation of asset trend: Smart money index does not indicate when to trade a particular asset. Rather, it represents what investors can expect from an asset in the short term. For example, if an asset has an upward trend, a smart money index can alert you when the trend changes.
- Variations in the smart money index and the market trends: Investors are constantly looking for changes in market trends related to the index trends. This is called the identification of divergence. If asset prices fall and the smart money index rises, this usually indicates that the price may rise.
The Scale of Smart Money
Investors with large followings, such as Warren Buffett, are considered smart money investors, but the scale of their activities is not always taken into account. When the cash reserves at Buffett’s company, Berkshire Hathaway, accumulate and are not invested, this is definitely a sign that Buffett does not see many value opportunities in the market. However, Buffett functions on a different scale. A $25,000 investment is not too significant in a billion-dollar portfolio.
Buffett’s smart money acquires companies rather than taking a position. Institutional investors of Buffett’s size need scale for overall portfolio impact. Therefore, even when the smart money is out of value picks in the current market conditions, it does not mean that there are no opportunities—particularly for modestly sized stocks.