As a retail trader, your orders will hardly have any influence on the overall market prices. However, when large investors such as commercial traders or professional traders place their orders, they will likely define where prices are heading. Therefore, it’s of extreme importance to find what these large traders are doing and to be on their side. In this article, we intend to explain how you can spot what the big players are doing, i.e., tracking the “smart money”, and take advantage of their actions.
What is the “Smart Money”?
So, what exactly is the “Smart money”? It’s the name we use to describe professional and large traders with a big amount of capital. In this category, we may find both institutional investors, investment banks and hedge/mutual funds. Not all funds can be considered professional since some of them lack the expertise or the size to truly impact markets. Besides, small funds usually do not have enough capital to place orders capable of influencing prices.
Besides being the traders with the largest amount of capital, these are also the traders with access to more information and knowledge about the markets. Note that both hedge funds and investment banks have huge teams of researchers continuously analyzing the market. They also spend large sums to have access to the latest news before the rest of the market. As such, the odds are that professional traders will spot some opportunities faster than the “average trader”. This is why it’s extremely important to know what they are doing. Due to the size of the organized actions of these traders, they are usually behind biggest price movements. Therefore, knowing what they are doing should be one of the first objectives of any trader.
Tracking the Smart Money
The most direct and efficient method to understand when these players act in simply by looking at a price-volume chart. Due to the large size of their orders, these traders are not able to hide their actions. There is a myth that says that because of dark pools, they are able to hide their actions. Some institutional traders do use dark pools, but they can only hide their orders during execution, which can be a matter of milliseconds. After the order is executed, there’s no way to hide it, as exchanges (and consequently Forex liquidity providers) will report it in the volume.
1- Interpret the direction of their trading
You’ll need to look at prices and volumes to know this. Our article about volume trading explains some ways to observe this. The important thing here is to see where there is a general and organized action, and various funds are buying or selling a currency consistently. You can see this in lower timeframes, like 1 minute, as well as in daily/weekly timeframes.
There are many supply/demand patterns, which our VSA indicator shows, and one of the most prominent SUPPLY ones is a wide range bar, closing on the lows, with volume above the average. The demand ones close on the highs instead. Even though these are wide range bars, many times the prices will continue trending, as you can see in the chart below.
2- Take a look at fundamentals
In long-term trading (daily timeframe and above), good fundamentals make it more likely for big traders to have an interest in a given currency. Traders should be aware when talking about “fundamentals” given that some economic measures like the GDP growth or the interest rate hikes, although important, are not a leading indicator. We frequently see these variables changing only after price corrections in the value of the currency. Traders are better off by looking to the increase of the spread of the interest rates or the movement of a related commodity. These variables are usually a good proxy for the fundamentals that drive currencies and often are leading indicators. In the image below, for instance, we can see how correlated are the AUD with the price of Gold. If the price of gold increases, large traders know that this will benefit the AUD and start buying the currency.
- Sentiment indicators such as COT report and SSI index will give you secondary information. Although it has its usefulness, COT report shows the actions of ALL large traders, even the ones that aren’t so good. Traders should, therefore, pay special attention to their analysis, because the report may have some lag in what comes to be a market turn. Traders should use the COT report mainly as a confirmation, or as a search mechanism for extreme values between large investors and hedgers. The image below presents some examples when the large spread was linked with a market turn
- On the other hand, the SSI shows the actions of small retail traders, which are usually wrong and in the opposite direction of smart money. In this indicator, look for historically high % of long positions to look for a short, and vice-versa for long positions. You can combine both information to be more confident about the right direction you should trade.
If you aren’t using volumes in your analysis, you are missing a big part of the picture. By showing the market’s activity, volume together with prices shows what the big traders are doing. Only these traders are capable of placing orders large enough, and in an organized manner, to sustain market trends, so you should look closely at what they are doing. By tracking the smart money, you can follow their actions and be on the right side of the price movement.
Feel free to comment below with any questions or feedback, and if you liked the article, share it with your friends!
In my previous EURJPY analysis I pointed out that the prices were just testing a down trendline, and given the accumulation seen behind, it’d be wise to wait for an up-breakout of the resistance. Subsequently, this trade was taken based on these developments:
- The background was strong at the time of breakout, which maximizes our chances.
- There was accumulation behind, shown by multiple demand signals without the price going to new lows. Note: there is a difference between the older post chart and this one, as the previous was from GMT-5 feed, while this is from a GMT+2 feed, both in Oanda. Nonetheless, the market picture is fundamentally the same.
- The break-out showed increased volume not exactly on the break-out bar, but in the next one. This is usually fine, but I prefer to wait for confirmation when this happens. The confirmation was given a few hours later, after the low volume down bar was broken to the upside, showing clear lack of supply in the market.
- The first warning sign to exit was the extreme volume up bar, with no follow-up. Later a Supply signal from the Daily showed up, which confirmed the weakness. Closed when the trend turned yello. The take-profit from an alert would give an exit around these prices as well. However, if you have the time to manage your trade, and can react to changing supply/demand in the market quickly, trading without take-profit with this system also works.
Right now I’m holding a short position in the daily, as this weakness is just below a long-term down trendline. The correction is seeing relatively low volumes, but that could be normal after the distribution seen on the red bar. Either way, the trend is still down, and so, I’m just watching where the market takes me for now.