Now hold up, wait a minute, smart money? Is this a new type of cash that spends itself in a blink of an eye, right before some sort of new iPhone enters the market? Well, even though the concept sounds funny, smart money refers to investments or transactions made by ‘expert’ investors. Most of these experts have a profound understanding of financial markets as they can quickly identify trends before others.
There is another category as well. It includes those investors who are not as intellectually gifted in spotting or predicting investment trends. It also includes those who are riding the pattern after the smart money has already made most of its profit. These investors are called dumb or stupid money. If you fall into this category, try not to take offense.
However, Smart money may refer to either shrewd investors who can spot market trends before others or the collective impact of big money that can move markets.
Fun Fact: Smart money was originally a gambling term. It referred to the wages made by gamblers with a track record of success. The investing world is similar. In the context of gambling, smart money relates to individuals who hustle hard and earn a living on their bets. Usually, gamblers utilize historical and practical mathematical algorithms to decide how much they should wager and on what. The same goes for trading and investing.
Many people believe the whole thing is a myth. The masses say that wealth managers and advisors on clients’ portfolios perform no better than the overall stock market’s average trend over any given period.
Understanding Smart Money
Smart money is the capital that is under the control of institutional investors, market mavens, funds, central banks, and other financial professionals. Thus, quick cash is considered to have a much better chance of success when the trading patterns of institutional investors diverge from retail investors. However, there is very little empirical evidence that supports the idea that smart money investments perform better than dumb money.
Smart money can also refer to the collective force and influence of a massive amount of money that can move the market. As an example, we can take the central bank, which is the force behind smart money.
Dumb Money vs. Smart Money
The terms dumb and smart money was instituted by the monetary media. They did not intend to insult anybody’s knowledge but instead wanted to depict various groups of investors.
However, as we’ve mentioned before, the fact that smart money has the experience to identify trends does not mean they are on a winning strike 24/7. They don’t always make intelligent decisions. Plenty of them makes bad trades from time to time.
The average investor generally does not have the time, experience, or patience to analyze corporate reports or the worldwide economy methodically. Since these financial specialists don’t have access to teams of analysts or deliberately arranged information, they frequently make trades dependent on their senses or a warning. Consequently, the “dumb money” group tends to buy and sell investments, even during a worst-case scenario.
Thus, most dumb money tends to purchase stocks when prices are on the rise. They will then sell those stocks when prices start to decline. For the average speculator, the stocks they are buying proceed to fail to meet expectations. The stocks they trade continue to perform quite well.
Overall, both groups position themselves very differently. However, the smart and dumb labels are often exaggerated.
How to Identify Smart Money
Well, most of the time, insiders and trading specialists typically invest more. Thus, identifying smart money is not hard, as one can notice an unnatural trading volume. It is particularly suspicious when little or no public data exists to justify the amount in exchange. Thus, by knowing who the smart money holders are and where they are investing, you, as a retail investor, can use it to your own great benefit.
However, on an individual basis, most professional portfolio managers and traders struggle to match the returns of blind index investing over a long time.
- Smart money is capital placed in the market by institutional investors, central banks, funds, and other financial professionals.
- Smart money also refers to the force that influences and moves the financial market. However, it is often led by the actions of central banks.
Usually, Smart money is invested on a much larger scale than retail investments.