Traders are often confronted by mixed signals.
Personally, when I have to choose between something straightforward
or something complex – simple is better.
For example, when large "Smart Money" traders show their directional bias, it often pays to follow in their tracks.
Another technique would be to bet against the smaller retail "Dumb
Money" traders (because, historically, they are often wrong at major
However, if I have to decide between following "Smart Money" or doing
the opposite of what "Dumb Money" does … then in the absence of other
information, following Smart Money wins because it is more
straightforward and simpler.
Here is an example.
chart, below, compares the bets made by small traders (a.k.a. the "Dumb
Money"), to those of large commercial hedgers (a.k.a. the "Smart
In practice, Confidence Index readings rarely get below
30% or above 70% (they usually stay between 40% and 60%). When they move
outside of those bands, it's time to pay attention.
noteworthy is when there is a wide confidence spread with bullish bets
by the Dumb Money and bearish bets by the Smart Money. This type of
sentiment spread only happens a few times a year. We often get
substantial bullish reversals when that happens.
So, early last week, I took notice of this chart from SentimentTrader. The confidence spread it shows was pretty close to extreme levels.
Conventional trading wisdom says that Crowds are usually wrong at
turning-points. That doesn't mean they are wrong all the time (yet, as discussed, it makes sense to notice when the Smart Money clearly disagrees). So, after such a strong rally, this is the kind of data that causes me to pay closer attention.
The Markets had been selling-off a litte. Would this be a trend-break or a buying opportunity? Would Smart Money start actively making Bearish bets?
As the next chart shows, two days was all it took to get back to the status quo.
That is why trend following works. Price is the primary indicator, and until it breaks down, dips will be met with buying.