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What is smart money in Forex trading and how can it give you an edge?

Updated: Aug 16

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.


If you are interested in getting coached by me, 1-on-1 coaching is a great service we offer. Please note that we only take a handful of traders that have already mastered the basics.


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.


When a market is ranging, liquidity tends to generate on both sides of the range. If smart money wants to be short, selling at the breakout to the upside of the range can generate enough liquidity to fill the orders. Why? Because people that are short have their stops above the range. A seller’s stoploss is a buy stop order, which is a buy order. You also have people buying above the breakout. This means there is enough buying for a bigger player to sell into. This is how they operate.


Building a position is also something smart money does and it can help you to get a trading edge, once you understand how it works. Let’s say smart money wants to be long at 1.20 in the EURUSD. Just hitting market at this price would create an immediate loss, but splitting the order up in different parts will make sure smart money gets an efficient fill. This is usually done during ranges and at places of high liquidity. These ranges are called accumulation and distribution ranges.


Wyckoff is known for identifying supply & demand in these ranges to establish what smart money is doing and to potentially join this player. By identifying ranges and analyzing what happens once liquidity gets triggered, you can get a trading edge. The Wyckoff method, but also the concept of liquidity, is the basis of our mechanical trading strategy. During our 1-on-1 coaching sessions you will learn all about this smart money way of trading.


On our Youtube Channel you can find videos about Wyckoff & liquidity that will further illustrate this concept and can help you to develop your own personal trading edge. We don’t like to market it as “smart money”, as it usually gives falls impressions.


How to identify opportunities?


So now you know how smart money operates and why they operate in a certain way, it’s time to teach you how to identify opportunities. The best way to do this, is to mark out the levels spoken about above, such as:


· Daily highs & lows

· Weekly highs & lows

· Obvious swingpoints

· Boundaries of ranges


By marking out these important areas of liquidity and then analyzing what happens once the liquidity at these areas gets triggered, you can get a better understanding of how smart money operates. You can then make up rules to develop an entire strategy around this concept. The next step is to backtest the rules and generate data to confirm a trading edge.


One of the best ways to identify absorption of liquidity by a bigger player, is to look at candle closes & the violence of moves. Is the high of a range being taken out, but price quickly and aggressively falls back into the range? Then the buyside liquidity above the range has been triggered and absorbed by smart money, to fill a short order.


Waiting for confirmation is often very important. You want to see clear triggering of the liquidity and then absorption of that liquidity, in order to join him. Our strategy is based around entering after absorption of liquidity.


The process of getting the rules and backtesting can take a long time. We at CDFX Trading trade a mechanical trading strategy that gives you tested & proven rules which you can execute in live market conditions to generate a profit, if done correctly of course.


During the backtesting it’s very important that you do this as objectively as possible, otherwise the results are not accurate. Focus on proving that the rules are wrong, instead of that the rules are right and make money. This gets rid of the “positivity bias” and gives you more accurate results.


Another thing that is important to realize is that a lot of people that market smart money, tell you to make 1:200 risk reward ratio trades. This is all fake. These guys don’t have any records. Taking trades with these types of trades is a recipe for disaster. You are trading mostly based on luck. The winrate off these strategies is extremely low. The only reason these people tell you to take these trades, is because it looks good and they can sell you their product. Be aware!


If you want to know more about why a 1:200 risk to reward ratio is bullshit, watch this video.


Take action now!


Smart money is very popular these days. I hope after reading this blog, you now know what it’s all about and how you can identify smart money. Now it’s up to you to take action. Build a plan, learn the concepts and start testing. If you want help, check out our education or coaching. If you have any questions, just contact us, we love to help out!