Why Smart Traders Make Dumb Trades

Hey Traders,

I’ve been talking a lot about “Smart Money” lately, and about how I use Smart Money trades to inspire my own trades (and my trades are even smarter than Smart Money!).

But … some of you may be wondering …

If Smart Money is so smart, and has tons of resources, and so much capital at stake …

Why isn’t Smart Money already making these trades themselves?

The answer is simpler than you may expect.

Think They’re So Smart …

First, let’s cover who exactly we’re talking about when we’re talking about “Smart Money.”

When I talk about Smart Money — which I use interchangeably with the term Big Money — I am essentially talking about institutional investors.

That is, I’m talking about hedge funds, banks, market makers, and other professional traders who control significant amounts of trading capital. 

These deep-pocket traders are referred to as “Smart Money” because they often have access to tools, resources, and information that your “regular Joe” retail trader won’t have. 

It isn’t necessarily nefarious access to “insider trading” intel so much as these kinds of institutions often hire trading and sector experts to get information first, invest in expensive trading tools and software, and generally just cash out on whatever it takes to trade ahead of the competition.

That’s why traders without those resources — like your average Joe retail trader — often pay close attention to what Smart Money is doing.

If we see someone’s betting millions of dollars that stock XYZ will go down, there’s a chance they know something we don’t, so if we follow their trade, we’re able to beat the rest of the market, and trade before the catalyst is “priced in.”

In fact, every Wednesday, I go over a Big Money trade in this Pit Report newsletter. Most recently, we covered a Smart Money play on Advanced Micro Devices (Ticker: AMD).

There’s also the fact that sometimes Smart Money injects so much money into a stock that their money acts as a magnet for more money.

Or market maker hedging and delta management can cause a stock price to “pin.” You can learn more about that in this video. 

Obviously, if you’re trying to make a trade on a stock, you would want to know about any huge Big Money open positions that could affect the movement of the underlying.

“Okay Mark,” you might be thinking, “then why don’t I just scan for Smart Money trades and buy in after them as quickly as possible?”

First and foremost, a lot of times these Smart Money trades aren’t what they seem to be on the surface.

One example I’ve been using lately is the massive 150,745 contracts of Ford (Ticker: F) 10-strike calls that were sold last week.

You might think that a huge order like this, where the trader is selling deep-in-the-money calls, might mean Smart Money thinks F is in trouble.

In fact, that wasn’t the case at all. This trade was tied to 14,000,000 F shares purchased, and was actually Smart Money making an adjustment to a position they opened last year.

It isn’t always as complicated as that. Sometimes it’s just a matter of figuring out whether the Smart Money move is opening or closing, or if it’s tied to underlying shares. The answer to those questions can completely change the meaning of a trade, so you do not want to think about piggybacking a Smart Money trade before you have a definitive answer.

Second, you don’t want to blindly follow Smart Money because Smart Money sometimes makes dumb trades.

Let me explain.

I’m not saying Smart Money makes losing trades.

I’m saying Smart Money doesn’t pick the best trades to make.

Why not?

Simply put: they don’t need to.

When you’re controlling millions or billions of dollars, you aren’t necessarily worried about whether you’re profiting 25% or 27%. Institutional investors aren’t concerned if they’re leaving $1 million in profits on the table when they’re already walking away with $10 million or $15 million.

They’re bringing in huge profits, and that’s all that matters.

Meanwhile, traders like you and I do care if we’re making the best trade possible — that’s how we make our money!

Also, importantly, Smart Money typically isn’t options-focused. They are more about the stock, and the direction that the underlying is going to move. Taking time to find the perfect options trade takes time and resources that Big Money traders simply don’t want to spend just to bring in a few extra percent profit.

That leaves room for options traders like you and I to optimize their moves for better profits.

There’s also the fact that Smart Money traders want their trades done, and they want them done now. They’re putting through huge orders, and their concern is getting their position filled as quickly as possible, not getting an optimal risk/reward ratio.

Smart Money also often has completely different motivations to their trade, whether its hedging, portfolio management, or trying to capture profits from the bid-ask spread. 

For example, take this Acceleron Pharma (Ticker: XLRN) trade. 

You might think that purchasing 12,250 190-strike calls is pretty bullish … until you see it’s actually tied to a short sale of 428,900 XLRN shares.

Rather than being a substantial bullish trade, this was actually done to achieve a delta-neutral short sale position — which is very bearish.

That’s why it’s so important to determine the story and motivation behind the trade before you try to piggyback off of it! 

Not to mention … institutional traders are rarely playing with their own money, which makes it much easier for them to settle for a trade that is “good enough.”

So you see why watching Smart Money trades can be a great way to find trading opportunities before the general market … but it’s absolutely crucial that you do this with caution, and are very thorough with doing your due diligence.

You can see more about my own Smart Money trading process in this video here.

I also offer a Smart Money trading service where I’ll do the deep dive for you, and optimize the “dumb” Big Money trades to deliver better results. You can find out more about that right here.

Stay smart out there!

Your Only Option,

Mark Sebastian

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