Smart Money, one of the most modern methods of technical analysis
Intro
Smart Money is a term used in the business world to refer to investors and knowledgeable and experienced institutions that significantly impact the financial markets due to the large amount of capital and information they have. Smart money, with a disciplined approach, includes decisions based on research and analysis, which is often the opposite of retail traders. Smart money includes investment institutions such as hedge funds, large banks, and trading companies. These institutions have access to extensive resources and information and make business decisions based on research, analysis, and an in-depth understanding of the financial markets. To learn more about this topic, stay with us.
Contents
Smart Money Features
Typically, Smart Money has a long-term investment horizon and is less involved in short-term trading. Also, due to their significant capital, they can influence market prices when entering or exiting positions. Their actions can be a leading indicator for retail traders, providing clues about market sentiment and possible price changes. Retail traders can gain insight into potential market trends by studying market data, volume, time, and price patterns.
Note that despite Smart Money often having a more informed behavior, they are not immune to errors, and their strategies can also lead to losses. That is why risk management is a crucial priority for Smart Money, and they use sophisticated risk management techniques to protect their capital. Remember that even experienced investors can make mistakes because markets are affected by many factors, and unexpected events can disrupt traders' best-laid plans. Therefore, all traders must develop a clear strategy and manage risk effectively.
Also, the key points about Smart Money are as follows:
- The ultimate goal of learning Smart Money is nothing but the ability to identify liquidity in the market.
- Smart Money is one of the most modern methods of technical analysis in financial markets.
- Learning Smart Money requires a basic understanding of the supply and demand concept.
- Smart Money is large sums of liquidity that institutions create to form new trends.
- The concept of Smart Money is used in all financial markets such as stock exchange, forex, and cryptocurrency.
- Traders look for areas where Smart Money fills its orders in it.
- Combining Smart Money with multi-timeframe analysis increases the win rate and the risk-to-reward ratio (R/R).
What is liquidity?
As we stated, Smart Money's purpose is to identify liquidity levels. Liquidity is the money that its existence in the market indicates the presence of big players. Therefore, the price always follows liquidity. Part of the liquidity is the levels where most traders' stop-loss orders are registered. These ranges are usually behind significant supports and resistances, historical ceilings and floors, psychological levels, trend lines, etc. That is why we recommend checking these levels carefully before entering the trade because the market will probably move towards these levels to collect liquidity in the future. For example, as you can see in the gold analysis image below, the market has continued to move in the opposite direction after collecting liquidity.
What does the Smart Money structure refer to?
Smart Money structures are not just a forex trading strategy but a whole philosophy of how markets work and state that market makers do their trading activities at certain price levels. So, a micro trader would do well to formulate his strategy based on what is happening with Smart Money. Candlestick charts are the most important tool available to identify Smart Money. Candlesticks reveal price behavior and market psychology instantly and without delay. Therefore, a trader should be familiar with candlesticks and the mindset behind each candle before analyzing the structures and concepts of Smart Money.
Read More: What is a Candlestick? The Use of Candles in Analysis and Trading Strategy
The most common concepts of Smart Money are:
- Breaks of Structure (BOS)
- Change of Character (CHOCH)
- Order Block
- Fair Value Gap (FVG) and imbalance
Breaks of Structure (BOS): BOS is the first market signal for price movement in a specific direction. In an uptrend, a break in the structure occurs when the price rises and rejects the last recorded high, and in a downtrend, it occurs when the price drops and rejects the last recorded low. You can see what we mentioned in the picture below.
Change of Character (CHOCH): A Change of Character means that the market trend changes from bearish to bullish or vice versa. In other words, a trend ends with CHOCH. For example, in a downtrend, the price moves down with the BOS of the price floor. The presence of BOS during a trend indicates that trend's strength. But suddenly, the price moves above the last formed ceiling, and we can say that the market structure has changed from bearish to bullish. We expect to see a new uptrend after breaking the last price ceiling.
Order Block: As the name suggests, order blocks are a collection of orders from banks and large institutions at a specific price. Order blocks work by creating an imbalance of supply and demand in the market, and due to having a large number of buy or sell orders at a certain price level, they create significant support or resistance at that level, which means that if the price returns to that level it is likely to bounce off that level and move in the opposite direction. Two methods are used to enter the trade after identifying the primary market trend and finding the correct order block. In the first method, after the price hits the desired area, we wait for the creation of a confirmation candle in the trend direction and then enter the position with the stop-loss behind the area. In the second method, which is a bit more aggressive, we enter the trade by placing an order limit. The second method's advantage is that it is entered into the trade at a better price, and the probability of being left out of the trade is minimized, but it is more risky. Below is an example of a bullish order block.
Read More: All you need to know about Order Block types
Fair Value Gap (FVG) and imbalance:
Fair Value Gaps are more commonly used among price action traders and are referred to as an inefficiency or imbalance in the market. This pattern forms when the power of buyers compared to sellers or vice versa increases suddenly, and this power imbalance causes a rapid price jump. The FVG pattern is displayed with three candles and includes parts of the second candle body not covered by the first and third candles' highest and lowest prices. Note that if the third candle is the same color as the second candle, this pattern is called imbalance, and we have the FVG pattern, which is stronger than the imbalance pattern when it is not the same color as the second candle. These areas are usually where many orders are placed, and we anticipate them to act like a magnet and attract the price in the future. It is also possible to expect a reversal price reaction to these areas.
What are the other methods of identifying Smart Money?
In addition to the price chart and observing the market structure we reviewed, they also search for traces of Smart Money with the following methods.
1. Trading Volume
Speculators who know the market typically invest more money. Therefore, the trading volume is higher, especially when no public information is published about determining the exact amount of these trades. It shows the same flow of Smart Money. Note that the volume in a forex broker is shown as Tick Volume, which is a relative measure of the actual trading volume.
2. The stock price and its related indices
One of the information sources published by informed market people is the stock price and its indices. This information is complex and uninformed, and beginners cannot understand it. Knowing the primary holders of Smart Money and where they invest is in the interest of retail investors so that they can trade in their direction.
3. COT Data
Some knowledgeable people use different methods and sources to collect data on commercial and non-commercial traders. One such source is the Commitment of Traders (COT) data. This data is published weekly by the Commodity Futures Trading Commission (CFTC). Many analysts use this information to determine future trading activities, which is probably from more knowledgeable investors.
Summary
In this article from the Trendo Broker educational team, we introduced Smart Money. There are many ways to make a profit in the financial markets. One of these methods is the Smart Money technique, the money that the market giants, banks, and financial institutions have used in the market and often gained good profit. When a trader can identify this money in the market and adjust his trades accordingly, he has connected himself to a reliable and profitable source and can make a good profit.
