Follow The Smart Money

| September 7, 2011

Market timing is something usually left to the pros.  And for better or worse, there are plenty of non-pros trying to time the markets these days.  While they may get lucky some of the time, a good percentage of these traders routinely guess wrong at the markets’ next direction…

If you’re interested in timing the markets, the “smart” traders are the ones you want to be following.  Simply put, the “smart” money identifies the best market timers.

On the flip side, the worst market timers are considered “dumb” money…

If you’ve ever guessed the market wrong (and who hasn’t), it doesn’t make you dumb.  Relax… I’m not insulting you.  “Dumb money” is simply the term used when evaluating who’s timing the market wrong.

Obviously, you want to be following the “smart” money as often as possible.  And there’s a way you can…

But before I show you how you can track the “smart” money, I’m going to give you a rundown on how these terms are developed and what goes into determining “smart” versus “dumb”.  Then I’ll show you the latest data and what it’s telling us about the markets right now.

Let’s get started…

The researchers over at SentimenTrader have devised a keen way to track this data.  They use sentiment extremes to determine the best time to buy or sell the markets.  And they break down the data by separating it into “smart” and “dumb”, as I explained earlier.

Here’s the deal on how they figure out whose timing the markets best, aka, the “smart” money…

The “smart” money looks at various indicators measured at historical extremes.  If an indicator shows excess pessimism near a market peak and excess optimism near a market bottom, it goes into their “smart” money index.  The “smart” money looks at items such as commercial hedger positions in the equity index futures.

On the flip side, if an indicator shows extremely high pessimism near a low and too much optimism near a high, it’s considered a “dumb” money indicator.  “Dumb” money usually gets bullish or bearish too late, when the trend is ready to reverse.  “Dumb” money looks at items like mutual fund flows and small speculators in equity futures.

How do you translate all this?

You’ll see the S&P 500 is the top chart.  I’ve circled where the S&P put in the bottom last month.  And the second indicator just below is the “smart” money.

Looking closely, you’ll see this gauge was peaking while the S&P was bottoming!

Below the “smart” money, you’ll find the “dumb” money.  And from the chart it appears everyone was bailing out when the market was tanking.  Using this indicator, we can see the selling got to an extreme level, indicating a buy signal.

Lastly, the blue line represents the spread between the “smart” and “dumb” money indicators.  This gives you a good understanding of when both groups are telling you to buy or sell…

And from all of the above charts… we clearly have a buy signal!

Not only is the “smart” money telling you to buy (as it’s above the “green” dashed line), but the “dumb” money is also giving you a green light.

And if that isn’t enough, you can see the “smart/dumb” confidence spread is also telling you now’s a good time to buy.

If you look closely above, it’s not always the case that all three indicators are flashing green… so now’s an especially good time to buy stocks according to these indicators.

Market timing is a difficult task, especially after heavy days of selling or buying.  But by following the “smart” money, you’ve got a head start on the rest of the markets.

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Category: Technical Analysis

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