Friday, October 23, 2009

Smart Money

There are a few indexes that are very useful in confirming an existing trend. As the market continues to rally, it is perceived to be a good sign when these confirmation indexes are also rallying to new highs. One such index is the Smart Money Flow Index, which is an offshoot of other last hour indicators published by Wall Street Courier. The index measures the market movement in the first 30 minutes and the last hour of trading. The first thirty minutes of trading is generally considered emotional trading, driven by greed or fear based on the overnight news. Therefore it is used a contrarian signal, which means that the index will subtract market gains or add market selloffs during this period. The last hour of trading is dominated by large institutions, or smart money, as they take the day to evaluate price action and execute orders in a big way. These big traders have the best research or information available to them, and therefore you would want to trade with them. The index will add market gains or subtract market selloffs during this period.

Below is a chart of the Smart Index from 11/1/08 to 10/22/09. As you can see from the chart the smart money is rallying with the overall market and confirming the strength in the market. This index has also been very useful in calling market bottoms and market tops. Going into the March lows, the index did not reach new lows when the Dow kept falling which signaled that most sales were due to ‘dumb’ money. That was an important sign as the heavy hitters were less fearful than other traders. We will keep monitoring this index for signs of divergences. If the market continues to rally and this index flatlines then it might be a signal that a near term top could be forming.