What is smart money in Forex trading and how can it give you an edge?
Updated: May 4, 2022
Smart money in Forex trading has become a bit of a buzz phrase. Everyone is talking about: “I trade smart money”, I trade “institutional”. In this blog you will learn more about what smart money is, how they operate and how you can profit from knowing more about smart money. You also learn more about the reality of this concept, because a lot of people use this phrase to market their courses.
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What is smart money?
Smart money is a term that’s often being used to describe the interbank market in the Forex market. These are the big banks, this is where the big money is being traded. Smart money describes a way these big players operate in a market. You have to realize that most of the business that is taking place in these banks is about filling orders, not taking directional positions. Most educators make it seem like the interbank market are these banks that are all about trading directional on small timeframes, this is usually not the case.
Most people also talk about “banks targeting their stoplosses”. This is also not really true. Retail traders are a very small group in the Forex market. However, it’s good to realize that even hedge funds and smaller banks get it wrong quite a lot, and place their stops at obvious spots as well. The liquidity at these spots can be used by smart money to fill trades.
There are some general concepts a trader can use to identify the objectives of smart money. By identifying the objectives, you can join the anticipated direction “smart money” has been positioned in. By building a strategy around this, you can develop an entire trading edge and become a so called “smart money trader”.
How does smart money operate?
Order blocks, break of structures, POI’s, all these terms are all over the internet today. They claim to help to identify what smart money is doing. These terms are usually marketing terms and refer to more common concepts, such as supply and demand. Don’t pay too much attention to these complicated names, these are all about selling courses.
The most important things you need to know about how smart money operates are liquidity and building positions.
Liquidity means the ability for a market to be traded. Generally speaking, you want to be trading a highly liquid market, like the Forex market. But why is it important?
Let’s say a big player wants to be short 100000 lots on EURUSD at 1.20, but there are only 50000 lots going long at this price, this means only half of the order gets filled short at 1.20. The other half of the order gets filled at a lower price, which means the bigger player immediately has a small loss. In order to combat this problem, a bigger player in the market needs to be careful about how he enters the markets.
This problem can be solved in a few different ways:
· By “generating liquidity”
· By building a position
· By triggering liquidity
These are the most important ways smart money can “generate” enough liquidity to get an efficient fill on his order.
Liquidity is mostly above and below ranges, above and below obvious swingpoints and above and below daily/weekly highs and lows. Knowing this information, you can highlight these areas on your chart and see what price does once these areas are hit.