Predicting Major Market Moves By Detecting the Smart Money
2. THE SMART MONEY
A) Money Flow
There are two critical factors that we as technical analysts observe to track where the smart money is going. The first is an indicator called Twiggs Money Flow and is similar to Chaikin Money flow with a few adaptations to account for gapping and some other factors.
Developed by Collin Twiggs, it is a method of tracking if a stock has the key factors that define a true uptrend.
These qualities include:
· price making higher highs and higher lows
· higher amounts of money or volume trading in the stock each day
· closing higher and higher in its daily trading range
· whether the range is expanding or contracting
If all of these qualities are in play traders agree this confirms an uptrend is truly in place and therefore the smart money is likely accumulating a position in the stock/index the indicator is applied to. If this is taking place the indicator will rise in value and continue to make new highs along with the stocks movement.
However, if we see that the levels of the market or a stock is increasing and this indicator is in fact going the opposite way, it could quite likely indicate that a bubble is building. This is called the distribution zone and means the rally that the stock or index is enjoying is likely the smart money off loading their positions to the public before a big drop takes place.
Inversely, if we see that the price levels of a stock or the market are dropping but the Twiggs Money flow is moving opposite this, in the upwards direction, than this indicates accumulation is going on an a possible strong reversal could be coming in the stock.
So let’s apply this indicator to the previous scenario discussed regarding the Head and Shoulder pattern during the market crash of 2007-2008 . See below a chart of the S&P 500 with the Twiggs Money Flow indicator charted underneath the stock. Note, that as the market climbed higher and higher, eventually going into a sideways movement and then the head and shoulders pattern, the Twiggs Money Flow indicator was actually making substantially lower highs and lower lows and diverging (moving the opposite way).
Now if we compare that to a weekly chart of the S&P 500 you will notice a strikingly similar image.
Of course we do not only apply this to the market but also for also for finding highly potentially powerful moves in stocks.
We will discuss some recent trade setups we alerted our students to recently where the Twiggs Money Flow played a key role in being able to predict the major move in the market.
In the below example you can see a chart of BBOX where you will notice a strong downtrend in place from the 21st of October 2015 onwards and you will notice that the money flow was dropping along with it. However as of the 17th of December all of sudden the Money Flow takes a sharp change to the upside and continues to make higher highs and higher lows as the stock continues to decline.
This divergence tells us that accumulation is going on and that the smart money is starting to shift in the bullish direction. Now of course the trick is to pick the right timing for entering this trade. This perfect entry point occurred on the 2nd of February. Not only did the Money flow continue to diverge, but it also crossed above 0 making it an even stronger signal. At the same time we also had perfect pattern confirmation with the stock breaking its downtrend line as well as the 9 day exponential moving average and the 20 day simple moving averages that were previously holding this stock down. The resulting move produced almost a 50% profit for anyone entering the trade.
This divergence can also occur over a shorter period of time. For example below is a trade we took on BCRX. After a massive drop the stock was going sideways yet the money flow was going up sharply. We therefore took advantage of getting into the trade on the 2nd of March. If you were a stock trader and entered in at the open this would of a resulted in a 20% intraday profit. Instead we opted to go for the June $2.00 calls which had a 60% intra-day move.
Now let’s take a look at a short setup. In the chart below we see a similar type of setup on LGF but with the opposite occurring. As you can see from the 23rd of June 2015, LGF continues to climb higher and higher in an upward channel. Now of course as we discussed earlier in this book we have already identified that an upward channel while it movies in an upward trend actually warns us of an impending break to the downside making it in fact a bearish pattern.
Notice as the stock climbs higher and higher in its channel the smart money is in fact moving completely the opposite way. Once again the key is timing the trade and what you will notice in the chart below is that LGF touches the bottom trend line a total of three times (re-enforcing the value of the rule of three) before breaking below it strongly along with the Twiggs Money Flow breaking below 0.
This was not only a great potential stock trade but a trade where we alerted our students to the value of purchasing long dated put options on the stock that have since moved over 1000% as the stock dropped from $38.00 to its recent low of $18.00.