Predicting Major Market Moves by Detecting the Smart Money

In today’s economic climate, investors are faced with a multitude of different sources of information, from Facebook, StockTwits, business news, stock newsletters and anyone who is willing to give you their opinion—which is everyone. 

Unfortunately, statistics show that over 85% of investors generally lose money. In fact, in a recent documentary I watched discussing the value of “experts,” it was reported that “economists have studied the wrongness rate in economic journals and have concluded it’s very close to 100%.” In conclusion, “virtually all the studies published in economic journals are wrong.”

Therefore, how does an investor know how to find the true story of what is going on? More importantly how can you find good investment ideas knowing that the likelihood is that 85% of them will be wrong?

The most valuable method I have found to predict major market moves and capture significant profits is by tracking the smart money, how it moves and the key indicators signaling which way the money is flowing. In this e-book we will discuss the ways in which we do this, plus key elements and checkpoints.

A complimentary workshop discussing the concepts and patterns discussed in this e-book will be provided at the end.

MARKET STRUCTURE AND DYNAMICS

Firstly, to set the premise of the ideas set out in this article, we must first look at the nature of how money moves through the stock market in today’s modern age. It is currently estimated that as much as 80% of volume in the stock market is accounted for by buy and sell decisions made by computerized trading. These powerful systems of algorithms make investment and trade decisions almost entirely based on certain patterns. These patterns occur in the charts of a stock and follow extremely precise pre-determined buy and sell targets based on the relative rules for the algorithm being used. Often fundamentals won’t be factored into the decision making at all.

Love it or hate it, we therefore feel that regardless of what opinions we may have of the fundamentals of the market, or what we feel “should” happen next, it is far more important to track what the patterns are saying. Once we know the pattern we can then utilize quantifiable indicators to look at what the “smart money” is doing. Based on this approach, we can observe how some of these techniques predicted the market crash of 2008 long before so called “experts” even started talking about it.

We will break down the reasons into several categories.

THE POWERFUL PATTERNS

Upward Channel Break

The most easily identifiable pattern on the S&P 500 is that of the longer-term upward channel, which can be observed by looking at a monthly chart dating back to the lows of 2011. While this is an upward moving pattern, the rules almost always dictate that after three touches of the support line there is a very high probability of a breakdown correction to occur. As indicated in the chart below (Figure 1), it can be seen that we have indeed touched three times and on the fourth touch of the week ending Friday Aug 21st , we broke through support and have confirmed this bearish move by rallying back to this line and being unable to break above it.

This “Rule of Three” not only applies to upward channels but also to other highly traded patterns such as ascending and descending triangles, head and shoulders, rising and falling wedges and almost all other oscillating patterns.

Often investors are sucked into buying support they have seen touch multiple times, feeling that the more times support has been respected the better. However, it is quite the opposite. By understanding this rule, we can anticipate when big money is about to step in and short the stock and avoid getting sucked into buying into perceived support at the worst time.

Head and Shoulders

While this pattern is harder to recognize for many beginner traders, this pattern is one of the most highly probable and profitable bearish patterns to occur in a bull market. Normally signaling the top of the market is what makes it so effective. This is a pattern designed to fool investors and traders into thinking the stock is making new highs resulting in investors being lured into buying the stock right before it begins its downward decent.

A head and shoulders pattern is characterized by a stock creating a symmetrical triangle up and down forming the left shoulder. This is followed by a larger symmetrical triangle representing the head and then a final right shoulder triangle usually of equal size and shape as the first. When this forms, it is assumed the stock/index will then break down to the amount of at least what the measurement of how large the head was. Also note that the breakdown occurs after three touches of the support line.

In the market meltdown of 2007 to 2008, the top of the market was characterized by a series of this exact head and shoulders setup. (see Figure 3 below)

In other words, experts and news aside, the “chaotic” breakdown of 2008 was in fact a drop that was highly predictable; and, in fact, where it dropped to and where it reversed from were levels that were almost exactly what the pattern of the head and shoulders had predicted. This illustrates how vital it is to understand the role such a powerful pattern plays in predicting big money moves.

An example of how this pattern can be applied in current markets, observe the way the S&P 500 has been currently moving in recent times. As you can see in the chart, it appears to be forming the beginning of yet another head and shoulders pattern and is perfectly timed with the other factors we will discuss later. If this were to continue, we have projected out what this would look like over the months to come. This would mean a likely 1600 target level on the S&P 500 at some time during the first or second quarter of 2016. These are rough measurements, but they offer a prediction of what a head and shoulders would look like if this pattern were to confirm by breaking down from the area displayed in the chart.

A break much above the 2000 level would indicate a failed head and shoulders and that smart money is going a different direction. This would indicate to us a signal to go long. We could see a test of the 2,100 level or a retest of the upward channel at 2,250 as it extends upwards to the right.

Understanding the patterns of the chart is one of the most vital aspects of trading in being able to determine where the money is moving. It also tells us the key levels at which the pattern dictates to us to buy and sell with highest probabilities.

THE SMART MONEY

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 and 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 Shoulders pattern during the market crash of 2007 to 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 for finding potentially powerful moves in stocks.

We will discuss some recent trade set-ups 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 example below, 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. The 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 nine-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 have resulted in a 20% intra-day 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 set-up. In the chart below we see a similar type of set-up 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 moves 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. 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

Bond Traders

The second key factor we look at when determining big moves of “smart” money is following the high-yield corporate bonds using one of the relevant ETFs, in this case “HYG.” Typically speaking, in a strong bullish market, money will flow into corporate high-yield bonds showing confidence in corporate America. If you observe the chart below, you will notice that HYG indeed correlated with the S&P in 2008 perfectly.

It followed the market down in 2008 during the crash and reversed with it from the lows of 2009. However, in the middle of 2013, while quantitative easing pumped more and more money into stimulating the market, the big money started to move the opposite way. This divergence was a key factor in how we predicted the crash of 2008 on June 6 along with the recent crash of the S&P back in July of 2015. Watching for when HYG is moving in the opposite direction of the S&P 500 is a fantastic way of predicting when big money moves are about to come along with reversals in either direction of the indexes.

OPEN RANGE

One of the most incredible pieces of the puzzle to predicting big money moves in the market is one of the best kept secrets of stock traders but one of the most powerful methods I have ever discovered. So much so that it is up to 80% accurate in predicting the direction of the S&P 500 and major indexes for a one- to three-week period! The strategy is called open range.

While there may be other interpretations of this term as it applies to the stock market, this specific strategy is applied by observing the daily range of trading on the S&P 500 on the first trading day of the month as well as the monthly options expiration Friday. After the range on one of these days is set, we are then watching for where the market closes in the days following to determine the bias of direction for the market.

In the days following the open range day we are looking to see if the S&P 500 closes more than three points above or below the range set. Whichever direction this occurs in first will set the bias for the market direction until the next open range day occurs.

So, for example, let’s take the month of February of 2016. On February 1^st, the trading range of the S&P was a high of 1947.20 and a low of 1920.30. The following day, the S&P 500 closed at 1903.03, more than a three-point close below the open range.

What this signal means in practice is that the market’s bias should be negative. This could mean the market could continue dropping straight down, or at the very least it should close below the top of the range set by the 1st of the month; i.e., close below 1947.20.

When the next open range day occurs on the third Friday of the month, the open range is considered to be reset and we are now looking for whether the market breaks higher or lower than this new open range to determine the bias for the next leg of the market between options expiration and the first trading day of the following month.

This is a key signal to us to decide in which direction we will scan for high probability set-ups for the immediate trading days/weeks following these breaks. Our research over the last several years shows this to be up to 80% accurate in predicting market direction.

SCANNING FOR THE PERFECT STORM

In this book we started off by discussing the critical importance of understanding what the pattern is in order to know how to trade it. Ultimately trading should never be about guess work or going to bed stressed over positions that feel more like unhinged gambles than educated, well managed trades.

Of course this is the whole purpose of understanding how to correctly identify what pattern a stock is in, and then to be able to decide whether that pattern is one of the highly probable and profitable patterns worth trading, or a more unreliable one we are better of passing over.

This is where scanning becomes an extremely powerful asset in our trading arsenal. Once we know what the highest probability patterns are, we can scan specifically for only those.

However, this is only the very beginning. We can also build into the scan all of the above conditions discussed throughout this book to search for opportunities where we not only have one of the highest probability patterns, but where all the other factors discussed are coming together in a perfect storm to predict a major money move.

Utilizing scans allows us to therefore specialize in only the highest probability set-ups and strip away all the noise that distracts us into bad trades. We can also then become highly effective in knowing the exact rules of how to trade a small handful of patterns rather than trying to be an expert at everything, which is almost impossible.

SUMMARY

As market technicians, we are basing the ideas of the book on rules and measurements drawn from practices that have proven to work over thousands of other set-ups just like this. However, the key to any long-term success in this market also relies on the ability of an investor or trader to know when the idea has been proven wrong and not lock himself or herself into any one mindset that can’t be changed if the data goes the other way. We are therefore always watching closely how the markets perform, and key dates such as open range, to anticipate whether we are on the edge of another large drop or a huge rally.

Once again, for those of you wanting to learn more about the charting techniques and smart money calculations we use along with other key techniques to track smart money activity, you can simply follow the link below to receive instant access to our workshop on this topic along with ways to profit from a major market correction.

THE SPECIAL OFFER

If you have liked John’s approach, visit this page to view his Market Madness: My Favorite Strategy To Trade The Current Environment class- www.TradingPub.com/Money4

About the author

John Seville is the Master Stock Trader of the Acorn Wealth Corporation. John grew up in a family very much involved in the mining arena that spent a great deal of time discussing fundamentals and stocks over the dinner table. John became exposed at an early age to the stock market and would watch the massive rise and fall of many of the mining companies he was observing. It became evident at this point that despite fundamental research, there were terrific moves in stocks prices both up and down that the fundamentals didn’t seem to be able to account for.

Since then, John has spent the last 11 years mastering the art of technical analysis as a method of finding trading opportunities in the North American equity markets. Using such techniques, John and the other Senior Traders at Acorn Wealth Corporation were able to identify exit points on the market prior to the crash in June 2008, again in April 2010 and most recently in July 2011.

Acorn Wealth Corporation opened in 2007 to become one of the few places where students could go to learn such powerful techniques directly from their mentors.