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Don't Get Tricked by the "Smart Money"An excerpt from the following live event:
Volume Spread Analysis is all about watching the smart money. So, who is the smart money? What is smart money? Your understanding of smart money may be different from somebody else's. So, let's work with this definition:
We're looking at the insiders, the people who have the big bucks. They're able to swing a lot of trades, they're able to create a lot of liquidity in the markets. In fact, they get discounts from the exchanges for providing this liquidity. They can do this with a lot of money, equipment, computers, and algorithms.
They do this to create a reaction. Perhaps you've heard about high frequency trading, HFTs? These are the guys with the big bucks. We're going to call them the smart money. Don’t try to trade against them. They have all the money in the world. We're nothing to them. If you try to trade against them, you're going to get crushed. You see price move suddenly and you think, "Oh, I got to get in on this." And you jump in on it. That's like trying to catch a falling knife. When you're too late to the game to get in on a big move, then you're likely to get your hat handed to you. What if you try to capitalize on the actions of the big boys?
So the smart thing for us to do is to identify where the smart money is doing its thing: where they're purposefully manipulating the market, and wait until right afterwards for the reaction that they are trying to create. That's the whole reason the smart money is manipulating the markets. They're waiting for a reaction. And what's that reaction? It's almost always some sort of a panic or fear. And we fall for it every single time. We are a bunch of sheep. We are retail traders and we are constantly thinking about money. We are overwhelmed with feelings and emotions. These guys know that.
Let's say you're in a trade and you're managing that trade. If you don't have much confidence in that trade, you get nervous or excited: your heart's racing, your palms are sweating and your mouth gets dry. This reaction may be typical when you're in a trade. And then all of a sudden, one of these HFTs fire off, and BAM! Now what do you do? You're thinking, "Oh, I had a big profit, now it's going against me and what do I do? Do I jump out? Do I stay in the trade? I was making money and now I'm losing money. Do I cut my losses, or do I stay in this...Is this a reversal or what?" This is the uncertainty and panic that the big money and HFTs are trying to bring about in the small retail traders. And the funny thing is they do it over and over. They do it on every market; they do it every day, and we fall for it every time.
A lot of people think that HFTs are just sitting there doing nothing until that happens. People think the big boys make all their money when that sudden movement happens and this is absolutely not true. I've heard people call them "stop hunters" for so long and that just cracks me up; they're not hunting stops, they don't give a crap about your stops. Some of them do, but by and large, they don't care.
So the first phase, is accumulation. They do it very slowly and very steadily. You know when you're looking at charts and your eyes are getting heavy, "Oh, it's getting so boring." You're just waiting for something to happen, waiting for some setup. Well, guess what? Those guys aren't bored; they're very slowly and very stealthily acquiring as many assets as they can. This takes place in areas of congestion and it takes place during very low volume. Now why do they do this? Well, they know full well that we're trying to track them. Traders have been on a mission to see what the smart money is doing for the past 100 years. Why do you think there were ticker tapes? Because we want to see what the big boys are doing, we want to get some inclination of what's going on in the markets.
Generally, when you look at a chart, you'll see something that looks like the image above from time to time. This is the accumulation phase. They're going very slowly, very methodically, very quietly and on very low volume, buying up as much as they can at a price that they believe is a bargain. Of course they've spent millions and billions of dollars to study this and to pay people to write algorithms so that they know when to start this whole process. This is going to look very typical. To you and me, we're just bored out of our minds, we're just waiting for something to happen. But those guys are busy.
Now, once they've cornered the market, they've accumulated most of the assets that were available to purchase at that time. Now they start marking things up. So what's the characteristics of a markup? You'll see a series of higher lows, and higher highs (see below). Basically, the bars just start rising. Again, they're going to do this on relatively low volume and they can do this, why? Because they're the largest shareholder of whatever is available at that time. They're going to do this in stages with a series of retracements and pull-backs. They do it over and over again. And they do it regularly and often.
But we have another way of being able to read and understand what they're doing: instead of reading volume, we're going to read the speed at which these orders are coming through. That's where they get their power. They have figured out that they can do this on really low volume, as long as they put the orders through very, very fast. So we're reading the speed of those orders, and we can accurately anticipate when retail traders are able to trade at that rate, and when it's impossible for the current group of retail traders to trade as fast as those orders are coming through.
So we have a helper here for our Volume Spread Analysis indicator. We read how fast the orders are coming through; it's very typical on these up thrust bars that we're going to see our SpeedTick indicator print. We're reading the speed of the ticks coming in and not the quantity. Because they do this on very low volume, in a sense, volume has an important part in trading. But in terms of the quantity of volume, it is not as important as you might think. The smart money figures that it is the quantity of volume that people are looking at.
So we've had accumulation and we've had a couple of mark-ups. Now we're going to get into distribution. Distribution, is where they make all their money. You may think that they're making all their money on those up thrusts? No, they're making their money on distribution. Remember they've purchased way down low. They ran it up, and now they're going to sell it off. It's very difficult to determine when this is happening. It looks a lot like accumulation: things get boring, you start falling asleep, you just want something to happen, you start trying to make something happen. Well, this is when these guys are making all their money. And again, they're going to do it slowly and steadily, and on very low volume, because everybody knows that we're looking at volume. And we figure, "Oh, if there's high volume, that's when the big boys are playing. And if the big boys are playing, I need to be playing too."
Invariably, these distributions end with a climax bar. This is not where these guys are making their money. You have all this distribution, and they've made all the money that they plan to make. However, they are still the majority holder of the available shares or contracts, or whatever you're trading. Then, because they're still the majority, they still can manipulate the markets. So they're going to clamp down on supply. What happens next? When they clamp down on supply, price sky rockets, really fast. And then all of a sudden, they're going to dump everything they have on the market, and they're going to overwhelm the demand with supply. And why do they do that? Because they want to start the mark down phase.
The supply rushes in overwhelming the demand. Prices drop faster than many can offload their holdings and price plummets. And you’re sitting there thinking, "What happened? What just happened? Was there news? Was there something that I didn't know about? How could I have known about this? How could I filter this out of my trade plan? I was so close to hitting my target on my trend trade, and now it's tanked." And you kill yourself trying to find an indicator to tell you how to know that this is going on. And why do they do it? Because they're going to do it again. They're done for that cycle; they've made all their money, and they're just going to wait and set you up for the next time.
There's three components to determine supply and demand in Volume Spread Analysis: volume, price spread, and the close of price. Now, I’m not looking at all volume. I'm looking at the buying and selling volume and how it comes into a given bar, and when it comes into the bar. There's a lot of information inside these bars that most people don't know about.
Now, I told you that we specialize in trading pull-backs. These are our regular bread and butter trades; this is what we do day in and day out and have been doing for over six years, and it hasn't changed in six years. We are always looking for, and adding, new tools to make what we do easier. But in over six years, we're not doing anything different, we haven't changed our method. We're looking to predict a pull-back. Essentially, by reading the price action inside each bar, reading the weaknesses in the market, and finding different and better ways to read these weaknesses, we can anticipate when price is likely to pull-back. And we're going to do this using a confluence of events. We can do it with our indicators by understanding what's going on right now and capitalizing on the most common reaction to these sudden events. The big boys are manipulating the markets. We need to know this because this tells us what's likely to happen next, every single time. As long as there are big boys in the markets, we will have our edge. They don’t seem to be going anywhere anytime soon.