Smart money Dumb money

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Smart money dumb money, It is said that the market is an independent entity, it moves on its own and no one, not even the richest man in the world or the wealthiest country, can move and control it in the long term. Do we actually know what moves the market? Who or what controls the patterns that keep repeating themselves, and allow us to ride the waves of success or failure?

The most common theory is that markets move based on supply and demand. When there are more buyers to a certain asset than there are sellers, the market will move up, in bullish patterns, until it reaches a point where there will be more sellers than buyers. Different reasons make traders choose their positions. Fundamental news and events, Technical analysis, Fear and greed and personal risk management are all part of the quilt that decides the market’s fate. Logically, if I understand all of these factors and can control my emotions, I should be able to achieve 100% success rate. In reality, no man or machine can reach an ever-lasting, always-correct, bullet-proof method that will generate the desired 100% success rate.

To help you understand the reason behind that fact, I would like to share a story with you. The tale of Smart money and Dumb money.

A young and ambitious analyst started working at a big brokerage firm. On his first day on the trading floor, while tracking global economic events, he encountered the most amazing pattern he has ever seen. Storms were raging in Russia, destroying crops of wheat which led him to believe that the price of wheat will rise. He looked at the chart and realized that 8 technical tools were combining together to generate a bullish market. The now very excited young analyst started placing his Long orders on the wheat believing that he will reap his profits and become the hero of the day.

The trading floor manager noticed the commotion, and after figuring out what the novice analyst did, he called him to his desk.

“Show me why you have decided to take that position” Said the manager.

After the young analyst showed him the strategy the manager continued. “It does look very promising. How sure are you of your trade?”

“I am absolutely sure the trade will be profitable” Said the young analyst with confidence.

“I understand”, said the manager as he picked up the phone and dialed the number of one of his brokers, “John, I want you to SELL 20 contracts of wheat at current market price.”
What happened next took our young analyst by complete surprise. The price for wheat dropped down through the buy orders and all the way down to the analyst’s Stop Loss order, taking him out of the position at a loss.

“You see”, said the manager, “you were right that the trade was MOST LIKELY to succeed, but never forget that there’s always a chance to lose a trade even with the most efficient trading method you have.”

What happened to our analyst is the same thing that happens to every beginner. The market is built in a way that makes a lot of people lose a small amount of money to a few traders that make a lot of money. In other words, the Smart money constantly traps the dumb money into investing in the wrong direction.

So who is considered to be “Smart money” and “Dumb money”?

Dumb money are the majority of individual traders that usually trade as a “side job” and don’t invest enough time to truly learn the market. These traders take trading advice’s from family and friends, maybe read a free E book somewhere online or take a free course. They are overconfident in their personal abilities, not realizing that the market is just waiting to devour them and leave them penniless.

And that’s usually what happens.

Smart money are the experienced traders who dedicated a sufficient amount of hours to learn and understand how the market moves. They realize how the dumb money thinks and know where the traps are laid. They treat trading as a business, and understand the importance of becoming a professional in your field before diving into the deep water.

In order to become a successful trader you have to first learn how the dumb money thinks, and then learn the ways of the Smart money.

To summarize, when we apply our trading methods on a certain market we have to remember 2 things:

  1. Trading is a sum-zero game. Meaning that in order to make money we have to be better than the trader on the other end.
  2. Successful trading is a game of probabilities. If you are making more money than you are losing (and you may have a few bad days), you’re doing the right thing.
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