Smart Money Confidence

For those reasons, you'll usually see Smart Money Confidence rise as stocks drop. They are the proverbial "knife-catchers" and it seems like they're always losing because it appears as though they're constantly fighting the trend. Which, in a way, they are.

As stocks rise, you'll usually see Smart Money decline. The more stocks rise, the less confidence these investors have that stocks will keep rising.

They get the moniker "smart money" because these investors tend to have their largest long exposure near market bottoms, and their least exposure near peaks.

When Smart Money Confidence is above 70%, the S&P 500 advances at an annualized rate of 35.0%. When the smart money is less than 30% confident in a rally, the S&P has still annualized a 7% return, which isn't bad. Because these investors often have underlying positions not reflected in the indicators, it's typically better to use this model more as an indicator to buy rather than sell. When the Smart Money gets very confident that stocks will rise, they usually do.

As long as Smart Money Confidence is not at an extreme, when it's rising we should generally expect prices to decline. It's only when Confidence rises above 70% that we should flip our opinion and expect that the market is now more favorable.

Likewise, when Smart Money Confidence is declining, it's likely because stocks are rising and will continue to do so. When Confidence gets very low, however, it's a yellow flag that returns going forward may get dicey.