Smart
Money & Dumb Money Indicators
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Why
Some People Almost Always Make Money in the Markets
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Smart Money & Dumb Money Indicators
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Where
Are the Customers' Yachts?
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| The
title is derived from the old Wall Street joke about a visiting client who
was receiving a tour of Wall Street. The guide pointed to the East River
and said, " There are the yachts of the powerful Wall Street Brokers,"
to which the gentleman replied, "Where are all the Customers' yachts?"
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It is common knowledge
that the members of the New York Stock Exchange do hold a significant
informational edge over other traders and investors as far as supply-and-demand
statistics and other fundamental and technical market conditions are concerned.
NYSE members are divided into three categories: Specialists, Floor
Traders and Other Members and they are the so called "Smart
Money".
Specialists There are 1366 NYSE members (i.e., seats) and approximately
450 of them are specialists working for 38 specialists firms. Each individual
specialist handles approximately 6 issues. The very big stocks will have
a specialist devoted solely to them. It is no wonder that the specialist
business is passed on from one generation to the next; it is the most
risk-free way to make a lot of money in the financial markets. The specialist
must buy and sell stock against the market trend to cushion temporary
imbalances and avoid unreasonable price variations—committing capital
to add liquidity when it is needed. If buy orders temporarily outpace
sell orders in a specialist's assigned stocks - or if sell orders outpace
buy orders - the specialist is required to use their firm's own capital
to minimize the imbalance. This is done by buying or selling against the
trend of the market, until a price is reached at which public supply and
demand are once again in balance.The New York Stock Exchange releases
information on a weekly basis on purchases, sales and short sales, made
by stock exchange
members and by nonmembers
(public). An example of the weekly NYSE Member Report can be found
in our Weekly
Market Indicators page.
Floor Traders are agents who act as an intermediary between buyer
and seller in trading securities. They earn a commission for this service.
The two main types of floor traders are commission brokers and independent
floor brokers. Commission brokers work for brokerage houses that are members
of the NYSE. Independent floor brokers work for themselves, handling orders
for their own clients or other brokerage houses.
Other Members
A member firm is a company or individual who owns a "seat" on
the trading floor. Only member firms are allowed to buy and sell securities
on the trading floor. To become a member firm, a company must meet rigorous
professional standards set by the Exchange. The number of seats has remained
constant, at 1,366, since 1953. All the others who hold a seat and are
neither specialists nor floor traders are the so called "Other Members"
and they are all the well known Wall Street broker firms. They have the
best brains and analysts working for them and the have tons of money as
well. What the directors of these firms say is not necessarily what they
are doing themselves. If they notice increased buying activity in the
small accounts they start selling and selling short immediately, while
they see "higher prices ahead" on CNBC.
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Smart
Money & Dumb Money Indicators
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| The chart below shows
you the spread between the short sales of the public (dumb money)
and NYSE specialists (smart money). There is a chart of the Dow Jones
for comparison below. If
specialists, floor traders and other members of the New York Stock Exchange
are shorting heavily the market is usually ripe for a correction. On the
other hand, if they are doing relatively little shorting it is most likely
that the market has hit bottom, especially if public- and odd-lot
short sales increase at the same time as you can see from the third
chart below. |
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| Another
dumb money indicator are the so called odd-lots.
Odd lot transactions are made by small investors who can not afford to buy
a round lot of 100 shares of a stock. These smallest of the small guys are
usually dead wrong at bottoms and tops. The chart below shows you the spread
between purchases and sales in dollars.They really plunged in when the market
corrected after the top in September 2000, because they expected another
big leg up. This is also a self-fulfilling prophecy, because the smart
money exits the market immediately whenever the small guys think that
the market is a one-way street up. Option speculators are also in the dumb
money camp.The call/put ratio of all CBOE
options reached its highest reading right on top as you can see from
the enclosed chart of the S&P 500. |
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| The Smart
Money Flow Index shows the action of the real pros and savvy money
managers. It is calculated by taking the action of the Dow in two time periods:
the first 30 minutes and the close. The first 30 minutes represent emotional
buying, driven by greed and fear of the crowd based on good and bad news
There is also a lot of buying on market orders and short covering at the
opening. Smart money waits until the end and they very often test
the market before by selling and shorting heavily just to see how the market
reacts. As soon as the notice resistance they reverse their positions and
move in the big way. These heavy hitters also have the best possible information
available to them and they do have the edge on all the other market participants.
If the Dow makes a new high, the Smart Money Index has to confirm the action
otherwise there is trouble ahead. On the other hand, if the Dow makes a
new low and the Smart Money Flow Index doesn't, watch out for a bear trap.The
arrows on the chart below show you the bullish and bearish divergences.
This magnificent indicator has called every major top and bottom since we
are online.(Smart
Money Flow Index explained) |
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| All market gurus tell
us that the investor must act contrary to the behavior of the so called
"crowd". The big question is: Who is the crowd?" The chart
above shows you the number of upticks minus downticks in large block transactions
of single trades of 10 000 shares and over. An uptick is at a price higher
than the last previous trade and initiated by a buyer. A downtick is at
a price lower than the previous trade and initiated by a seller. The rationale
behind the Large
Block Index is quite simple. It measures activities and extremes in
institutional sentiment and behavior. When the ratio of upticks rises to
very high levels, it indicates that the institutions are buying heavily,
reaching a fully invested position and therefore lowering their cash reserves.Conversely,
when the ratio of downticks rises to high levels, it indicates that the
institutions are selling and are raising cash. When the institutional behavior
reaches extremes, the market will turn in a contrary direction. This indicator
has often signaled major reversals and indicates that the instutional money
managers are also the "crowd", or dumb money, if you look
at the enclosed chart of the Dow Jones for comparison. |
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The
problem of the Internet is that you have as many gurus as financial web
sites and you don't know whom you should believe. We are of course as
bullish at market tops and as bearish at bottoms as everybody else, but
we stick to our indicators. And anybody who has the slightest idea about
technical analysis will agree that our indicators do indeed make sense.
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An abundance
of charted financial information for about a quarter a day!
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Past performance does not guarantee future results!
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