Distinction between Real Flows and Money Flows are as follows: Unlike a traditional economy where production is mainly for self-consumption, production in modern economy is for exchange or sale. Thus, modern economies have become exchange economies where all.

Real Flow And Money Flow Diagram
Explain Real Flow And Money Flow With The Help Of Diagram
Difference Between Real Flow And Money Flow
Real Flow Vs Money Flow Graph

Troy Bombardia
Published: 2020-01-12 at 06:42:42 CDT

The Smart Money Index (SMI), also known as the Smart Money Flow Index, is a technical indicator which tries to gauge what the 'smart money' is doing vs. what the 'dumb money' is doing in the U.S. stock market. It suggests that investors and traders should follow the 'smart money' instead of the 'dumb money'. In this post you'll learn about:

In 1994 we had $10,000 per month in cash flow, primarily from our rental real estate properties, and only $3,000 per month in living expenses. At that point we were free. Our money was working hard for us, instead of us working hard for our money.
If your income statement shows you made a $30,000 net profit last month, you would have to check the cash flow statement to know that your partner spent $50,000 on a lavish party for the vendors. That’s why you don’t have enough money to make payroll this week. Cash flow statements track profits, but also how the money was used.

What is the Smart Money Index (a.k.a. Smart Money Flow Index)

The Smart Money Index, or Smart Money Flow Index, was popularized by Don Hayes in the 1990s and seeks to understand what the 'smart money' is doing relative to the 'dumb money'. This indicator exists in different variations, but is based on the same concept:

The “dumb money” trades at the start of the day since they're emotionally reacting to the overnight or early morning news. Trading on the news is not a smart thing to do. Meanwhile..
The 'smart money' trades during the last hour of each trading day since they spend the day evaluating the market's price action.

As a result of this concept, the Smart Money Index states that savvy investors and traders should bet on the stock market's direction towards the end of the day since that is what the 'smart money' is doing, and bet against the stock market's direction at the start of the day since that is what the 'dumb money' is doing.

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How is this indicator calculated?

So how exactly is the Smart Money Flow Indicator calculated? What counts as 'start of the day' and what counts as 'end of the day?

Calculate the S&P 500's nominal gain or loss during the first half hour of trading (9:30 a.m. - 10 a.m.)
Calculate the S&P 500's nominal gain or loss during the last hour of trading (3 p.m. - 4 p.m.)
Today's Smart Money Index = yesterday's Smart Money Index - the market's gain/loss in the first half hour of trading today + the market's gain/loss in the last hour of trading today.

Here's an example. Let's assume that the Smart Money Index's value yesterday was 5,000. The S&P lost -14 points this morning and gained +8 points this afternoon. The Smart Money Index's latest value is now 5000 - (-14) + (+8) = 5022.

Here's another example. Let's assume that the Smart Money Index's value yesterday was 5,000. The S&P rallied +9 points this morning, and gained +7 points this afternoon. The Smart Money Index's latest value is now 5000 - 9 + 7 = 4998.

The Smart Money Flow Index can be calculated for any stock market index. The one that's frequently quoted in mainstream media is for the Dow Jones Industrial Average. But since the S&P 500 is a better representation of the overall U.S. stock market, we have calculated the SMI for the S&P 500. Here's what this indicator looks like:

If you have a Bloomberg Terminal, you can find this indicator going back to the 1930s for the Dow Jones Industrial Average.

How to use the Smart Money Index

There is no hard-and-fast rule for how to use the SMI. There is no exact point in which we can say 'the Smart Money Index is bullish for stocks right now' or 'the SMI is bearish for stocks right now'. With that being said, traders generally use this indicator to 'confirm' the stock market's trend or look for 'divergences'.

Confirming the trend

If the market moves in the same overall direction as the SMI, then the SMI is 'confirming' the stock market's direction, which suggests that the trend will continue.

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”.
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”.

Divergence

If the market trends in a different direction than the SMI, then the stock market will eventually mean-revert to the SMI’s direction. This means that..

Real Flow And Money Flow Diagram

If the stock market goes down but the Smart Money Flow Index trends higher ('smart money is more bullish relative to dumb money'), that’s seen as a “bullish divergence” for the stock market. Theory states that the stock market will probably go higher soon.
If the stock market goes up but the Smart Money Flow Index trends down ('smart money is more bearish relative to dumb money'), that’s seen as a “bearish divergence” for the stock market. Theory states that the stock market will probably go lower soon.

Between these 2 uses, traders more commonly look for 'divergences' since divergences can help traders predict major turning points in the market. 'Bearish divergences' are usually more common than 'bullish divergences' for this indicator.

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Does the Smart Money Index actually work?

How useful is the Smart Money Flow Index? Does it actually work, or is it just another one of those indicators' whose logic 'sounds' really smart but in real-time is not much better than a 50/50 coin toss?

It's hard to quantitatively test this indicator to see if it works, since the term 'divergence' is hard to quantify. No 2 traders staring at a chart will define a 'divergence' the exact same way. (This is why I prefer quantitative trading over discretionary trading - it clears up ambiguity).

Explain Real Flow And Money Flow With The Help Of Diagram

Since the most common use is to look 'bearish divergences', let's see if the Smart Money Index's 'bearish divergences' with the S&P 500 were able to predict major historical market tops.

2018 stock market crash

While the U.S. stock market was trending higher from Q1-Q3 2018, the Smart Money Index was trending lower. This was followed by a stock market crash in Q4 2018. In a sense, this did warn of the impending stock market crash.

October 2007 bull market top

The U.S. stock market peaked in October 2007, but the Smart Money Index peaked more than 3.5 years earlier in February 2004. This was not a very useful warning sign for the U.S. stock market. When an indicator has been saying 'BEARISH DIVERGENCE' for 3.5 years, it isn't very useful for market timing because it encourages the trader to turn bearish too early. Being too early isn't a whole lot different from being too late.

March 2000 bull market top

The U.S. stock market made a flat top from March - August 2000. Meanwhile, the Smart Money Index peaked in August 1999 and had collapsed by March 2000 (bearish divergence). Overall, this was an effective timing indicator for predicting the stock market's top.

January 1973 bull market top and 1973-1974 bear market

Real Flow Vs Money Flow