What is Smart Money?

Last Updated: 4 Jul 2022

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 a massive following, like Warren Buffett, or Rakesh Jhunjhunwala, are considered smart money investors. However, the size of their trades is not always considered. If their company’s cash reserves are piling up and not being invested, this means they don’t see many opportunities to create value. But such investors operate on a different scale altogether. A $30,000 investment is not that important to a $1 billion portfolio.

Their smart money buys businesses, not merely a position. An institutional investor at that level needs to scale to witness an impact on his portfolio. So, even if smart money loses value in current market conditions, it does not mean that there are no opportunities, especially for small stocks.

Final word

‘What is smart money’ explains that capital is steered by institutional investors, financial entities, central banks, funds, and other financial professionals. Often controlled by central banks, smart money also refers to the force that significantly influences financial markets. Lastly, smart money is invested on a much larger scale compared to retail investments.

Frequently Asked Questions

1. How can I get smart money?

There are largely 3 ways of identifying and then following smart money. These indicators are trading volume, stock pricing and index options, and specific data sources and methods.

2. What is smart money buying?

Smart money refers to the capital that institutional investors, central banks, and other financial institutions or professionals control. The general perception is that this money is invested in the right investment vehicle at the right time and will generate the highest returns.

3. What is smart money and dumb money?

Average retail or individual investors who trade are often considered under the ‘dumb money’ umbrella, whereas, large institutional investors and financial companies are called ‘smart money.’ These terms were coined by the financial media, not to belittle one group over another, but to describe different groups of investors.