The Art of Smart Money Trading: Bank and Institution Strategies

23 Jun 2023

The realm of finance is replete with a plethora of phrases and terminology, and among the most prevalent is the notion of "smart money." This term commonly alludes to seasoned traders who possess access to a wealth of information and knowledge beyond the reach of novice traders or individual investors. Within the domain of cryptocurrency, the concept of smart money often pertains to significant institutional investors, banks, hedge funds, and corporations that engage in market investments. This comprehensive article aims to delve into the origins of the smart money concept, elucidate its pertinence to trading practices, and expound on how banks employ smart money strategies to generate profits. Additionally, we shall closely examine the three fundamental phases that constitute a bank's trading strategy: accumulation, manipulation, and allocation.

The concept of smart money has its roots in the recognition that certain market participants possess a distinct advantage due to their extensive experience, robust networks, and access to specialized information. These seasoned individuals or entities are deemed to possess a higher degree of expertise, enabling them to make astute investment decisions and exploit market inefficiencies more effectively than the average trader. In the realm of cryptocurrencies, the presence of smart money often exerts a significant influence on price movements and market trends.

Large institutional investors, such as banks, hedge funds, and corporations, are typically considered as the primary bearers of smart money within the cryptocurrency landscape. These entities have the financial resources, expertise, and infrastructure to conduct extensive research, employ sophisticated trading strategies, and execute substantial transactions in the market. Their actions and decisions often carry substantial weight and can sway market sentiment, prompting other market participants to follow suit.

Banks, in particular, leverage smart money strategies to capitalize on market opportunities and generate profits. Their trading strategies encompass three distinct phases: accumulation, manipulation, and allocation. During the accumulation phase, banks discreetly amass positions in a particular cryptocurrency, taking advantage of lower prices and limited market awareness. This phase allows them to build substantial positions without significantly impacting the market.

Following accumulation, banks proceed to the manipulation phase, wherein they employ various tactics to influence market sentiment and price movements. These tactics can include spreading rumors, initiating coordinated buying or selling actions, or employing technical analysis techniques to trigger specific market reactions. By skillfully manipulating market dynamics, banks aim to generate favorable price movements that benefit their accumulated positions.

Finally, during the allocation phase, banks strategically distribute or liquidate their holdings to maximize profits. This phase entails careful execution and timing to ensure optimal returns. Banks may employ a range of trading techniques, such as scaling out of positions gradually or employing algorithmic trading strategies, to efficiently allocate their holdings while minimizing market impact.

Understanding the dynamics of smart money and how banks utilize smart money strategies provides valuable insights for individual traders and investors. By monitoring the actions of these institutional players and comprehending the phases of their trading strategies, market participants can potentially identify trends, anticipate market movements, and align their own trading decisions accordingly.

What Is Smart Money?

The concept of smart money originated from the gambling industry, where less experienced players would bet on the winnings of more experienced players. In the trading world, the creator of the smart money strategy is trader Michael Huddleston, also known as the Inner Circle Trader (ICT). According to Huddleston's theory, the cryptocurrency market is predominantly controlled by big players who are seasoned trading professionals. These individuals determine the asset's price and the direction of the current trend as they operate with significant volumes of invested funds. Their behavior is considered "smart" due to their experience, awareness, and often access to important insider information, contrasting with the "dumb money" formed by inexperienced traders who lack crucial market insights.

For instance, a study conducted by BDC Consulting in August 2021 revealed that major market players and professional investors hold approximately 42.66% of all existing Bitcoin tokens. This means that almost half of the coins are managed and regulated by individual companies, renowned personalities, hedge funds, and other entities seeking to profit from cryptocurrencies.

Examples of smart money traders include large banks like JPMorgan Chase and Citibank, central banks, hedge funds, and prominent institutions such as insurance companies and global corporations.

The smart money strategy primarily involves analyzing the behavior of these significant market players. The core principle of the strategy is often summarized as "follow the smart money." Understanding and utilizing this strategy in trading is essential due to the influence of powerful investors on price movements. One of the main mistakes made by traders is neglecting this factor and solely relying on technical analysis. However, it is important to recognize that major market players are also familiar with these technical analysis algorithms and can anticipate how traders will react in specific market situations.

Consider the following example: Intraday traders identify a triangle pattern on the chart, characterized by converging price ranges forming an angle towards a single point. Based on their analysis, they anticipate an upward rally with a breakout above the upper boundary. However, the price unexpectedly bounces downward, only to recover its upward movement after a certain time interval. Such price behavior can be interpreted as the intervention of big players who were able to profit from the situation and force traders to close their positions due to stop losses.

Trading Strategies Of Banks

Trading strategies employed by banks involve several phases to maximize their profits in the forex or other markets. One commonly used strategy can be divided into three distinct phases.

Phase 1: Accumulation
The first phase is crucial for banks and serves as the foundation for the subsequent steps. Banks cannot enter a trade with their entire capital all at once, especially when they aim to create a significant market movement in their desired direction. This approach prevents retail traders from simply copying the banks' trades, which could lead to long-term issues.

To address this, banks accumulate entry points for long or short positions over a period of time. They strategically make small purchases or sales, depending on the market direction they seek to stimulate. For instance, if the banks aim to initiate an uptrend, they open numerous long positions at intervals of hours or days. While retail traders may perceive the market as consolidating or moving within support and resistance levels, they are actually witnessing the actions of the big players building their positions.

Phase 2: Manipulation
The second phase involves market manipulation, which can take various forms and is often known by terms such as "false breakout," "false push," "hunt stop," or bull/bear trap. During consolidation periods, retail traders frequently place pending trades above or below the consolidation zone, hoping to capture a breakout when it occurs. However, the banks strategically create false breakouts, triggering the activation of these trades and then abruptly reversing the direction, triggering stop losses. This manipulation is a key reason why many retail traders lose money.

Retail traders often lack effective breakout trading strategies and fail to consider where most traders have placed their stop losses. This lack of awareness makes them vulnerable to the banks' manipulation of the market, resulting in losses.

Phase 3: Allocation
The third and final phase is allocation, where banks make their last significant push in the desired direction. Their previously hidden positions become evident, creating potential profit opportunities for retail traders. As the market begins an uptrend and retail traders try to follow by opening buy trades, banks employ a contrarian approach. They sell when the crowd is buying and buy when the crowd is selling. This contrarian trading strategy allows banks to accumulate positions in preparation for a new trend that typically moves in the opposite direction.

At this stage, the price may enter an overbought or oversold area, indicating an imminent reversal. It is a critical moment for traders to be cautious and consider the banks' contrarian actions, as it signifies a potential shift in the market trend.

Applying Smart Money Strategy

One of the most popular strategies in smart money trading is the identification and utilization of Order Blocks. This strategy is based on understanding how banks and investment firms execute their trades in the market. When major players wish to buy or sell large volumes of an asset, doing so in one trade would significantly impact the asset's value, potentially reducing their profitability. To mitigate this, they often use order blocks to distribute their trades more evenly in the market.

Regular traders also benefit from this feature as it influences the price but in a more balanced manner than if the major player executed their trades all at once. On a Japanese candlestick chart, the starting point for placing an order block is a price pattern where the subsequent candlestick in a strong impulsive movement completely overlaps the previous one. For example, at the beginning of a bearish trend, a red candle overlaps a green one, and vice versa for a bullish trend. The order block zone often becomes a level to which the price tends to return after all the orders have been closed, providing potential trading opportunities.

In practice, the placement of an order block can serve as a signal for an impending reversal when the price reaches its peak. Depending on the color of the candle that initiates the order block, traders can open a long or short position, with green indicating an upward movement and red indicating a downward movement.

Smart money trading also involves the use of other price patterns, such as:

Imbalance or Fair Value Gap: This candlestick pattern depicts a rapid and significant price movement, either up or down, without opposing orders. It occurs when there is an absence of sell trades during an upward impulse or buy trades during a downward impulse. The area where the price moved too quickly becomes a level where the price is likely to return in the future.

Breaker Block: This pattern indicates that the price has surpassed the order block level. It can appear on the chart as a strong impulse candlestick that disrupts the existing price structure, potentially leading to a significant shift in the market.

By understanding and applying these price patterns and the concept of order blocks, traders can align their strategies with the actions of smart money participants and potentially improve their trading outcomes.


Example of Smart Money Concept chart.

Criticism Of Smart Money

The smart money strategy faces criticism from experienced traders who question its validity and practicality. One major criticism is that the strategy is based on postulates that are difficult to prove. It is argued that the notion of major players seeking to manipulate ordinary traders lacks concrete evidence. Additionally, the specific strategies employed by large investors and companies in the market are not clearly defined, and obtaining this information is challenging, often requiring insider knowledge that may not be readily available.

Furthermore, the smart money strategy is sometimes viewed with skepticism due to its complexity and the use of specialized terminology that differs from standard trading language. This complexity can be overwhelming for beginners, potentially hindering their understanding of other trading strategies. Moreover, since the smart money strategy originated in the traditional currency market, there are doubts about its applicability to other markets such as cryptocurrencies or stocks. However, it should be noted that there have been instances where the strategy has been successfully applied in these markets, debunking some of these doubts.

Overall, while the smart money strategy has its proponents, it is not without its critics who raise concerns about its empirical foundation, complexity, and applicability across different markets. Traders should carefully evaluate and assess the strategy's principles and techniques before incorporating them into their own trading approach.

Advantages And Disadvantages Of Smart Money Strategy

The smart money approach in trading offers several advantages, but it also comes with certain disadvantages. Let's explore them in more detail:

Advantages:

Reduced risks: Following the movement of smart money and basing trading decisions on it can help reduce risks. When traders accurately identify the actions of large investors, there is a higher probability of successful trades and lower chances of incurring losses.

Stability: The smart money strategy focuses on steady income rather than quick and large profits. It can provide a reliable and consistent approach for investors who prefer a more stable investment strategy rather than making short-term market forecasts.

Confidence: The concept of smart money can provide psychological comfort for many beginner investors. By aligning their trades with the actions of experienced and knowledgeable market participants, they may feel more confident in their investment decisions.

Disadvantages:

Reduced liquidity: One potential drawback of the smart money approach is that when large amounts of capital move in one direction based on the actions of major players, it can impact the liquidity of the asset. This can make it more challenging to enter or exit trades at desired prices, potentially leading to slippage or limited trading opportunities.

Speculative bubble risk: Following the movements of smart money can sometimes lead to speculative bubbles. In such cases, the interest in an asset is driven not by its inherent value but by a pattern of behavior among market participants. When the bubble reaches its maximum point, it can burst, causing a sharp decline in the asset's price.

It is important for traders to consider both the advantages and disadvantages of the smart money approach and assess their risk tolerance and investment goals before incorporating this strategy into their trading decisions.

Conclusion

The smart money trading strategy revolves around analyzing the actions of major players in the market, such as banks, hedge funds, central banks, and large institutions. It is crucial to grasp the fundamentals of this strategy to avoid solely relying on technical analysis and to align your trading approach with the movements of smart money traders.

Smart money traders follow a well-defined trading strategy that encompasses three key phases: accumulation, manipulation, and profit-taking. During the accumulation phase, these traders accumulate positions gradually to avoid significant market impact. In the manipulation phase, they may employ various tactics, such as false breakouts or stop hunting, to manipulate the market and catch retail traders off guard. Finally, during the profit-taking phase, smart money traders exit their positions and capitalize on their accumulated profits.

For retail traders, it is essential to learn how to identify and follow the trend established by smart money players. Understanding their behavior can provide valuable insights into market direction and potential entry and exit points. Additionally, using stop losses effectively is crucial to protect trades from unexpected market moves orchestrated by smart money traders.

Remember that comprehending the operations of smart money traders is a significant factor in achieving success as a trader. By studying their strategies and actions, retail traders can enhance their decision-making process and improve their overall trading performance.