Trading Mistakes to Avoid – Not Understanding How the Market Really Works

One of the biggest mistakes traders make is believing the market moves based on news, fundamentals, or some logical reaction to external events. Good news sends stocks up, bad news sends them down. An earnings beat will lift a stock and a miss will tank it. It seems obvious, right? Not exactly. The truth is far more complex—and failing to understand this is why so many traders consistently lose money.

The reality is that markets don’t move because of what’s happening in the world. They move because of what the smart money is doing. And if you don’t understand how the smart money operates, you’re setting yourself up to become their liquidity—the fuel that feeds their profits.

How the Market Really Works

Let’s start with the basics: the majority of trading volume comes from institutions, hedge funds, market makers, and other professional traders managing billions of dollars — the Smart Money. Retail traders like you and me make up a tiny fraction of the market volume.

The smart money is…well…smart! They have the smartest minds money can buy crunching numbers, analyzing data and programming killer trading algos. They also have the best and freshest information that money can buy, and they get their data and news before dumb money traders like us. They accumulate positions when prices are low and sell when prices are high. But they don’t simply wait for prices to hit their desired levels. They have the funds to actually create the opportunities to buy low and sell high. When the smart money billions move, the market moves.

Here’s the Smart Money playbook:

1. Accumulate at Low Prices

The smart money wants prices to be cheap before they start buying in bulk. To get there, they might:

• Let demand dry up and watch the price fall.

• Short the stock to drive prices lower.

• Use negative news or rumors to spark panic selling.

This is why markets often drop on “bad news” that doesn’t seem all that significant. The news isn’t the real driver; it’s the excuse the smart money needs to bring prices down.

During this phase, you’ll often see hammer candlesticks on the chart—where prices recover sharply after a deep sell-off, accompanied by heavy volume. These hammers show the smart money stepping in to stop the decline and start accumulating.

For example, just recently the market was trading at its highs for several ways and moving even higher on relatively low volume. Suddenly, a news story broke about Russian President Putin insinuating that he might use nuclear weapons in the Ukraine war, and the market quickly began to plunge. The indexes came down a percentage point or so, and then quickly recovered and moved even higher.

Was that news story really the fundamental driver for the quick market plunge? If the world was really afraid of Putin using nuclear weapons, would the markets recover in the span of an hour or 2 and continue to move higher? Unlikely.

The more plausible explanation is that the smart money wanted to buy stocks, but not at full retail prices. They only buy at deep discounts, so they used the Putin story to trigger a sell off and generate some panic selling, primarily by retail traders, to drive the prices down. When the prices were low enough, the big volume bought the dip, on the cheap, and ride the market back up for a tidy profit.

2.Test the Market

After accumulating, the smart money may push prices up slightly to see if sellers are still waiting. This is called a low-volume retest. If there’s little resistance, they’ll start driving the price higher.

For example, let’s say stock ABC hits a major resistance level at 100 and then starts to sell off on heavy volume and reaches a support level at 80. The selloff could have been triggered by a change in fundamentals, a news headline or a general market move. The reason for the move doesn’t really matter. The only thing that matters to traders is that the smart money has decided to sell the stock and reap their profits, and has also probably decided to short the stock.  But in order to sell stock in the kind of volume that the smart money does, they need to have buyers.

Once the stock price has hit 80 and sellers have been exhausted, the smart money can either start covering some of their short positions and take their quick 20 percent profit (100 to 80) or they can push the price higher and then short it again. So they do a little short covering and start buying a little to create the impression that the stock is starting to reverse and rebound. Coincidentally, a positive news headline might come out or perhaps a rumor about a merger or takeover.

Suddenly, the stock price starts moving higher and retail traders following the stock, thinking that the worst is over start buying in the high 80s. Before you know it the stock is back to 90. However, the move up has been on low volume — a combination of smart money tease buying and retail FOMO. Don’t forget, the smart money has no problem buying tens of thousands of shares to get retail buyers excited about the stock move.

At 90 the smart money decides that it’s time to continue their original plan. As retail buyers continue to pile into the stock as it pushes higher, the smart money gets busy selling the shares they bought back at 80, making another nice profit, and adding to their short positions. As the stock starts to push lower, retail traders either get stopped out or scared out of their long positions, causing the selling pressure, and volume, to increase. Now the stock drops breaks through the 80 support on heavy volume and continues lower.

Here’s the final recap: Smart money sold at 100, bought back at 80 and sold again at 90, making nice profits. Retail traders bought in the high 80’s through 90 and sold at a loss. [The only way to avoid this retail trap is to watch the volume behind a move.]

3.Distribute at High Prices

When the smart money accumulates enough stock, the price pushing higher. This could take a while, with a slow and steady price bumps, or it could happen over a day or 2, with a big surge. When retail traders see the price surging they pile in, driven by FOMO. This is exactly when the smart money quietly sells into this enthusiasm, locking in their profits.

By the time the market feels euphoric, the smart money has completed their selling. When retail traders are buying at the top, the smart money is preparing to drive the prices back down to begin another money making cycle.

Most retail traders get it wrong because they assume markets move logically based on external factors like earnings reports, news, or economic data. But these are only secondary causes. The real driver of price action is supply and demand created by the smart money.

This misunderstanding leads to common mistakes like chasing breakouts that turn out to be fake and panic selling during sharp drops engineered by institutions to buy cheaply. Retail traders let their emotions, like greed and fear, direct their trading, playing right into the hands of the smart money.

Another favorite smart money tactic is stop hunting. They know retail traders place stop-loss orders just below support or above resistance. By pushing prices slightly beyond these levels, they trigger those stops, forcing traders out of their positions. This shakeout creates the liquidity needed for smart money to enter or exit positions, and to reverse the price in the opposite direction. Retail traders, meanwhile, are left confused and frustrated as the market reverses right after they’ve exited.

Most retail traders are doing the exact opposite of what they should be doing. When prices are surging and the volume starts to decrease, they are allowing their FOMO to make them chase and buy at the highs. When prices are plunging and hitting lows, they are selling into the panic just as the drop is losing steam and preparing to reverse. Retail traders are basically trading against the smart money instead of with it, and are getting skinned and gutted in the process.

Align Yourself with the Smart Money

To trade successfully, you need to think like the smart money and align your strategies with theirs. The goal isn’t to outsmart them—that’s nearly impossible given their vast resources and influence—but to recognize their patterns and position yourself accordingly.

Accumulation and distribution phases are key aspects of how the smart money operates. During accumulation, they quietly buy stock at low prices, often in tight ranges accompanied by heavy volume. Indicators like hammer candlesticks or unusual options activity can reveal their presence. Conversely, during distribution, the smart money offloads stock at higher prices while retail traders pile in, driven by euphoria.

Price action and volume are essential tools for identifying the movements of the smart money. Price action tells the story of market behavior, while volume reveals the intensity behind that story. A price breakout or breakdown without significant volume is often a trap, designed to lure retail traders into impulsive decisions. The smart money operates in large size — their moves tend to come with substantial volume. When volume confirms a price move, it’s far more likely to be a genuine smart money play. Paying attention to the volume on price moves can help you identify smart money movements and enter trades when the smart money is buying and exit before they start selling.

Even if you do correctly read the volume on a move, patience is key. The smart money often waits for a retest of a significant level before fully committing to a direction. These retests, where former resistance becomes support (or vice versa), are opportunities for traders to enter with reduced risk. Also, placing stop orders further away from the “obvious” levels will help you avoid being a victim of smart money stop hunting.

Bottom Line

Perhaps the most challenging aspect of aligning with the smart money is mastering your emotions. Fear and greed are the weapons the smart money wields against retail traders. They profit when traders panic or chase trades out of FOMO (fear of missing out). When markets are euphoric and prices are surging, it’s often a sign that the smart money is selling. Conversely, when fear dominates and prices are plummeting, the smart money is usually buying. Remember Rothschild’s famous advice: “Buy when there’s blood in the streets.” To succeed, you must resist emotional impulses, trust your analysis, and act when others hesitate.

Trading is not about outmaneuvering the smart money—it’s about recognizing their strategies and following their lead. By carefully observing price action, volume, and sentiment, you can learn to identify when and where the smart money is active. The smart money leaves clues for those who pay attention, and success lies in aligning your trades with the winners instead of fighting against them. Failing to heed those clues will keep causing you to be on the wrong side of trades.

Don’t fight the smart money. Trade along with them, and you’ll give yourself a much better chance of success.