How to Trade in a Market Driven by Algos and Smart Money?

Imagine that you’ve just bought some call options on the SPY or SPX, based on your analysis of the price action and a clear chart pattern you’ve identified. You’ve calculated your risk reward, gotten the perfect entry and set your stop loss at an appropriate level. You’re confident that the probability is in your favor. And now you wait to see whether the market will agree with your directional view.

The next couple of candles head in the right direction and you’re getting excited for the move to continue higher. Everything is looking peachy until, out of nowhere comes the biggest candle you’ve every seen ripping to the downside with a correspondingly robust volume bar, destroying your bullish trading thesis and taking out your stop, along with thousands of others. About a minute later, the price action has fully rebounded and made a higher high.

You leave the trade feeling dumbstruck, frustrated and violated. Your original thesis was correct. You had everything lined up perfectly. So what happened?

Algo Trading

Algo, or algorithmic, trading is when computers are programmed to automatically place trades based on algorithms.

In the U.S. equity market, European financial markets, and major Asian capital markets, algorithmic trading accounts for about 60-75 percent of the overall trading volume.

These algos have no emotions. They don’t get nervous or frustrated, and they don’t second guess themselves. They simply buy and sell when their algorithms are triggered.

There are news algos that trigger based on the words in a news story. Before you even hear about the news, the algos of the “smart money” (market makers, institutions, major money managers and traders etc) will act on it and either buy and sell. You’ll see that massive candle soaring or diving before you have any idea as to why.

algo candle

There are algos programmed to trigger based on keywords in statement made by the Fed or other market moving personalities. You’ll be listening to Chairman Powell answer a question during a press conference and he’ll use a certain adjective and suddenly — here come the monster candles.

There are algos that trigger at major support or resistance levels, which is why you will often see massive buying or selling programs at these levels.

Countering Algo Candles

While there’s no way to know when and how algorithmic selling and buying programs will trigger, there are some ways to counter their effects or keep from getting run over by them.

    1. Don’t let FOMO get the best of you when you see those huge algo candles bursting higher on a piece of news. In most cases those price spikes will reverse and come back down to earth, with force. There could be various reasons why this happens:
      • the news was fake
      • the reaction to the news was very overblown
      • the smart money planted the news and ran up the price in order to get retail traders to FOMO buy, in order to unload their own long positions.

      Give things time to shake out and see if the jump in price holds and then continues with volume. If it turns out to me a real move higher on legitimate news, then you can consider going long. If you want to play a riskier move, you can wait for the price to peak and then go short. Of course, the price can continue to move higher.

    2. Don’t day trade around scheduled market moving events, like Fed speak and economic data releases. These events usually trigger major algo driven moves, which will most likely stop you out. Wait until after the algo candles have triggered to evaluate the market and decide to enter a position.
    3. If you’re trading during headline driven times, trade with smaller positions to manage your risk in the event that you get caught on the wrong side of an algo candle.

Avoid Fake Outs

The Smart Money, particularly market makers, can move the market up or down for brief periods on low volume. They do this in order to find the inventory they need to fill their own buy or sell orders at the very best price.

For example, say a smart money trader wants to buy 100,000 shares of XYZ stock, currently trading at 90, because he knows that the stock is due for a pop. Let’s assume that filling 100,000 shares will cause the prices of XYZ to moves 3 points. In fact, other traders might see the stock start moving higher and start buying because they think the stock is breaking out, which could push the stock even higher. Therefore, the trade might end up costing hundreds of thousands of dollars more than if the entire order could be filled at 90.

Instead of trying to buy XYZ at 90, the smart money trader will start selling a smaller number of shares to drive the price down. Let’s assume there’s a support level at 87, beneath which traders have most likely placed stop orders. The smart money stock selling will trigger the sell orders, a technique known as stop hunting.  When retail traders see the price break below the support level, many will think that the stock is breaking down and will sell, driving the price even lower. This is when the smart money trader will take the other side of all of those sell orders and purchase his 100,000 shares a few points below the original 90.  Then the stock will reverse and head back higher, leaving the smart money trader with a tidy profit and the retail trader with a frustrating experience.

The only way to try to avoid getting faked out by the smart money orchestrated price drop is to look at the volume of the move. If the relative volume is low, you can assume that there’s a good chance the move is a temporary manipulation. You try to avoid getting stopped out by placing your stops some distance from the usual areas where stops are often clustered.

Play Along

You will never beat the smart money. But you CAN try to follow along with them by either taking the opposite sides of their low volume fake out moves, or by following their large trades as identified by tools such as blackboxstocks.





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The tool I personally use to track options flow is blackboxstocks. If you want to follow the smart money, this is a great tool for doing that, which will easily pay for itself if used properly. They also have a very useful chat room that goes along with the scanner. They're running a huge holiday sale now for up to 50% their regular monthly price. Click here to get the deal.
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