There’s been a lot of chatter about the Smart Money Flow Index in the past couple days. The Smart Money Flow Index or Smart Money Index (SMI), as it’s often called, is a sentiment indicator that attempts to measure the activity of the ‘smart money’ (professionals) vs. ‘dumb money’ (amateurs) in the U.S. Stock Market. It has been flashing warning signs to traders this past week, as it has been diverging from the S&P 500. This would suggest that the ‘smart money’ is selling out ahead of the ‘dumb money’ and that we should expect stocks to sell-off from here. Others argue that the Smart Money Flow Index is a misunderstood indicator and not nearly as empirical as the name leads on.
— Liz Ann Sonders (@LizAnnSonders) March 6, 2019
Here’s a tweet from Liz Ann Sonders, Chief Investment officer at Charles Schwab & Co (@LizAnnSonders). The yellow line is the S&P 500 index while the white line represents the Smart Money Index. Note that the Smart Money Index has begun to roll over in recent days.
The tweet below is from Arun Chopra, founder of Fusion Point Capital (@FusionptCapital). He makes the point that most people simply take The Smart Money Flow Index by its literal name instead of taking the time to understand how the indicator is actually calculated.
Here we go again. Smart money vs 'dumb' money making the rounds. Hopefully you have all read how the index is actually constructed vs assuming the name of it has a literal meaning. $SPX $XLK $EEM pic.twitter.com/Y65lBFzRDd
— Arun Chopra CFA CMT (@FusionptCapital) March 5, 2019
The Smart Money Index is centered around the idea that the ‘dumb money’ trades during the first half-hour of each market day, while the ‘smart money’ trades during the last hour of the day.
Take a look at the formula for the Smart Money Index:
Today’s SMI = Yesterday’s SMI – the market’s gain (or loss) in the first half hour of the trading today + the market’s gain or loss in the last hour of the trading day.
In a comment to the Chart Report, Arun Chopra explains:
“The problem with this indicator is that it’s based on the assumption that ametuers only trade the open, while professionals only trade the close. Essentially it looks at when people trade vs. something more tangible. People are just enticed by the name of the indicator but fail to look under the hood”
“Technicals are helpful but there’s a lot of ridiculous names for indicators out there like the Death Cross or the Hindenburg Omen that people just take at face value.”
Arun’s comments raise an important point about how we tend to blindly accept these indicators. The Smart Money Flow Index seems to be based around a questionable assumption. In addition, it doesn’t actually decipher between the transactions of professionals vs. amateurs as the name might lead one to believe.
When using these technical indicators, always be critical of how they’re calculated and how the data is being presented. Things are not always what they seem!