Smart Money Index: what you should know about this sentiment indicator


The Smart Money Index (SMI), also called the Smart Money Flow Index by Bloomberg, is a technical indicator that is supposed to gauge “smart money” vs. “dumb money” in the U.S. stock market.
The concept behind the Smart Money Flow Index is simple. The SMI states that

  1. The “dumb money” trades during the first half hour of each trading day (9:30 am to 10 am), while…
  2. The “smart money” trades during the last hour of each trading day (3 pm – 4 pm).

*The index was invented by Don Hayes.

How to calculate the Smart Money Flow Index by Bloomberg.

Here’s the formula for calculating SMI.

Today’s Smart Money Index = yesterday’s Smart Money Index – the market’s gain (or loss) in the first half hour of trading today + the market’s gain or loss in the last hour of trading day.

SMI can be calculated for many markets and their accompanying indices, including the S&P 500 and Dow.
The Smart Money Index that’s commonly quoted in financial media is calculated from the Dow Jones Industrial Average. Here’s an example of the indicator’s formula in action.

  1. The Dow goes up 100 points in the first half hour of trading. Hence, the Smart Money Index today = yesterday’s reading MINUS the Dow’s gains.
  2. The Dow goes down 100 points in the first half hour of trading. Hence, the Smart Money Index today = yesterday’s reading PLUS the Dow’s losses.
  3. The Dow goes up 200 points in the last hour of trading. Hence, the Smart Money Index today = yesterday’s reading PLUS the Dow’s gains.
  4. The Dow goes down 200 points in the last hour of trading. Hence, the Smart Money Index today = yesterday’s reading MINUS the Dow’s losses.

Based on this indicator’s logic:

  1. If the market goes up at the start of the day and goes down at the end of the day, it’s a bearish sign for the stock market. This indicator believes that the “dumb money” is buying at the start of the day and the “smart money” is selling at the end of the day.
  2. If the market goes down at the start of the day and goes up at the end of the day, it’s a bullish sign for the stock market. This indicator believes that the “dumb money” is selling at the start of the day and the “smart money” is buying at the end of the day.

The idea behind this technical indicator is simple. The “dumb money” is seen to often trade early in the day as they react hastily to the previous night’s news. “Trading on the news” is not a smart thing to do. The “smart money” is seen to trade near the close, when they can properly evaluate the entire day’s price action.
In a sense, this is semi-correct. All of our models trade near the daily close. Sometimes the market fluctuates heavily during the intraday. That’s why we wait until the end of the trading day, when we can rationally digest all of the market’s movements and the latest information. (The “dumb money” is seen as non-professional moms-and-pops who read the financial news each night after work and then place buy or sell orders the next day).

Smart Money Index right now

Here is the Smart Money Index’s chart and data.

[wpdatachart id=32]
Click here for the latest data on the Smart Money Flow Index

How to use the Smart Money Flow Index

Traders commonly use the Smart Money Index to confirm the U.S. stock market’s trend. If the market moves in a different direction than the SMI, then conventional technical analysis states that the stock market will eventually mean-revert to the SMI’s direction.
This is similar to how breadth indicators are used. They’re used for confirmation and non-confirmation. Non-confirmation is seen as a “bullish divergence” or “bearish divergence”.
Confirming the trend

  1. If the U.S. stock market rallies and the Smart Money Flow Index trends higher at the same time, that’s seen as a bullish sign of “smart money confirmation”.
  2. If the U.S. stock market falls and the Smart Money Flow Index trends lower at the same time, that’s seen as a bearish sign of “smart money confirmation”.

Bullish divergence
If the stock market goes down but the Smart Money Flow Index trends higher, that’s seen as a “bullish divergence” for the stock market.
Bearish divergence
If the stock market goes up but the Smart Money Flow Index trends down, that’s seen as a “bearish divergence” for the stock market.
Traders more commonly look at this technical indicator for “bearish divergences” instead of “bullish divergences”. Bullish divergences are rare.

Does the Smart Money Flow Index fall and make a bearish divergence before bull markets top?

The Smart Money Index tends to trend downwards before a bull market in U.S. stocks ends.
2000 bull market top
The U.S. stock market peaked in March-September 2000, after which a bear market ensued. Meanwhile, the Smart Money Index peaked in mid-1999, after which it trended downwards (bearish divergence).

2007 bull market top
The U.S. stock market peaked in October 2007, when its bull market ended.
However, the Smart Money Flow Index had peaked long before the stock market peaked. SMI peaked in February 2004, after which it trended downwards.

Clearly, this “bearish divergence” lasted for a LONG TIME before it actually had a bearish impact on the U.S. stock market. It wasn’t useful and timely for predicting the bull market’s top.
Any trader who turned bearish because the Smart Money Index was falling while the stock market went up would have turned bearish far too early (3.5 years too early, to be exact).

Smart Money Flow Index right now

Here’s the Smart Money Flow Index right now, as of late-2018.

As you can see, the U.S. stock market has trended upwards throughout 2018, while the SMI has crashed. This means that throughout 2018:

  1. Most of the buying has occurred during the first half hour of each trading day.
  2. Most of the selling has occurred during the last hour of each trading day.


Is this a medium-long term bearish sign for the U.S. stock market?
There is a good reason to believe that the Smart Money Flow Index isn’t as useful as it used to be. This is not as bearish as you think.

The Smart Money Flow Index is not very useful when you look at the overall data

Let’s look at the Smart Money Index holistically, from 1932-present.
This technical indicator often makes extremely long “bearish divergences” that last for many years.

As you can see in the above chart, the Smart Money Flow Index fell throughout the entire 1960s while the U.S. stock market went up. The U.S. bull market ended in December 1968, after which a bear market ensued.
Hence, this was not a useful tool for timing the stock market’s tops. The Smart Money Flow Index has a LOT of failed bearish signals.
If a “bearish divergence” lasts for too long, then it is useless. By the time the stock market does fall, it is still higher then when the “bearish divergence” first began!
You can look at the Smart Money Flow Index’s entire data.

The last hour of trading is no longer “smart money”

This technical indicator sees the last hour of trading each day as “smart money”.
The last hour of each trading day has always seen heavy volume as traders rush to get their orders in before the daily close. However, trading is becoming increasingly concentrated in the last hour of trading thanks to the rising popularity of ETF’s, even moreso than it was before. These ETF’s need to recalibrate their components every single day, and many do so near the closing bell.
Everyone trades ETF’s nowadays. Mom-and-pop investors, professional traders, hedge funds, etc. In other words, everyone is “trading” at the end of the day, including “dumb money” mom-and-pop investors who buy ETFs.
Hence, the last hour of trading is no longer dominated by “smart money”. It is increasingly dominated by algorithms and passive index funds that are neither “smart” nor “dumb”. That is why the Smart Money Flow Index dropped so fast during the stock market’s correction from January-February 2018. ETF’s have a massive impact on the market’s daily close. Human traders are being increasingly squeezed out by machines at the end of each trading day.
This chart shows just how quickly ETFs’ assets under management have grown. It has soared over the past 10 years by a factor of 8x.

This chart shows the spike in volume during last half hour of trading day. Trading soars in the last hour not because the “smart money” is buying and selling. It soars because EVERYONE is buying and selling, dumb money included.

This chart shows how volume is being increasingly concentrated on the close.

The most popular version of the Smart Money Flow Index has another secondary problem – it’s calculated by using data for the Dow Jones Industrial Average.
The problem with the Dow is that it’s too focused on big stocks. The Dow only covers 30 stocks. The S&P 500 is a much better gauge of the entire U.S. stock market because it includes mid-cap stocks as well. (The S&P accounts for approximately 80% of the whole U.S. stock market’s market cap).

The problem with Smart Money Index and other sentiment indices

All sentiment indices, such as the Smart Money Index and the Citigroup Panic/Euphoria Model, have the same problem.
In the U.S. stock market, it’s unclear who the “dumb money” is and who the “smart money” is.
Conventional financial “wisdom” believes mom-and-pop retail investors and traders to be “dumb money”. It considers professional traders, hedge funds, and institutions to be “smart money”.
This may be the case in the currency, commodity, and bond markets. Professional traders and investors tend to be more profitable in those markets than retail traders and investors.
But this most certainly is not the case in the stock market.
Fact: over the past 10 years, most professional traders and hedge funds have CONSISTENTLY underperformed “dumb” buy and hold because a lot of their trading strategies simply don’t work. For example, they use seasonality to trade, when the data proves that seasonality isn’t consistently useful for trading. These “pros” as a class underperform when the market’s going up and underperform when the market’s going down.
Hence, who’s to say who the “smart money” really is?
In reality, there’s no such thing as “smart money” or “dumb money”. Whoever makes money is the real “smart money”.
All sentiment indicators – including the Smart Money Flow Index by Bloomberg – have the same problem.
They have too many FALSE sell signals.
These indicators make too many “bearish divergences”. Many of these bearish divergences don’t amount to anything, which leaves users of these indicators no better off than flipping a coin.
If an indicator like the Smart Money Flow Index has too many false signals, then it isn’t very useful.

8 comments add yours

  1. Troy.well put. So much technical analysis which used to work no longer works. I’ve been trading for thirty years and can tell you that you are dead-on about technical analyis not being any better than a flip of a coin.All those Elliott Wave guys now use alternative counts (LOL) to show that they’re correct all the time even when the market turns against them. “Well, I told you that the market could also go down too as well.”
    Besides, you don’t see any technical analysts who are billionaires, but there are plenty of fundamentalists like Warren Buffett, Carl Icahn, George Soros who are billionaires.
    But every trader has at least one good indicator that has carried him through thick and thin. Mine is a liquidity indicator, which is *not* a buy or sell signal, but tells you how much liquidity is available in the market to buy everyone shares. At the end of 2008 and begin of 2009, the Intermediate term suddenly rose very high about 76%. even with the markets continuing to fall. However about Aug 20 to Sept 25 a month ago, it turned down from 58% to about 20%, which it has not done for years. And Today, with the market rising almost two percent, the intermediate term dropped even further to 11. I have never seen it so low, but the Long term is holding steady at 60. So the way I interpret it is, that the long term investors aren’t selling just yet. But the intermediate term investors continue to sell which usually means over the next 3-6 months, we could see some sideways trading instead of new highs or perhaps a bigger decline, perhaps a Thanksgiving day rally, but it doesn’t look like it has enough money to buy everyone’s shares and drive the price action up. But the long term liquidity has enough money to drive the market up.

    • I completely agree with you in terms of technical analysis. Very interesting comment. I will highlight this in tomorrow’s post.
      And thank you for spending the time to write such a long and informative comment!

    • Interesting. Is this a publicly available indicator or would you be willing to share how you are measuring liquidity?

    • What data does your indicator consist of? Where can I see these data? I also use a different view on the market, not popular, and my vector is also directed upwards. Its reliability is high, above 85%.

  2. Sami, it’s not publicly available. I made it up over the years and kept fine-tuning it until it automatically reacted to increased M3 money supply, stock buybacks, institutional money which can support the stock market . It has about 75% fundamentals and 25% technicals. The reason I bought it up was to show that most technical analysis doesn’t work because everyone uses the same indicators and most software programs use them. But this and one other indicator still works for me because nobody else knows how to use it. It’s not a buy or sell indicator, but it does work well as a risk indicator so I reduce my assets when risks are higher, when intermediate term liquidity drops, it doesn’t mean the market will fall, it only means the potential for the market can drop quickly on bad news or if investors panic (like now) because the people who normally buy the dips are now gone.

    • What do you mean intermediate term liquidity, isn’t all liquidity the same (i.e. cash)?

  3. Hi Troy
    You have demonstrated that the SMI is not a reliable indicator for the medium long term predictions of the market.
    But have you ever studied the possible correlation of the SMI with S&P in the short term (a day or two)? When the so called “smart money” sells hard in the final hour od trading day, what happens the day after, 2 days after, and the week after?

    • That’s an interesting question Carlo.
      Unfortunately, I don’t have the intraday data for that. To do such a study, you would not just need the SMI (which takes into account the opening hour), but only the data for the closing hour.

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