By just knowing how smart money operate in the market you can gain an edge in the financial markets and no matter if you're a profitable trader or not, knowing the concept that I'm about to share with you in this article can give you more insights into the structure of the FX market.

The number one reason why you would want to know how smart money operate in the market is the ability to proper time the market. Timing the market is one of the greatest challenge that any trader can have. The capability to spot market turning points before they happen can yield higher risk-reward ratio. By having the ability to enter a trade as close as possible to the market turning point, you enjoy 3 major benefits:

  1. Low Risk: By entering as close as possible to the market turning price you can use small SL order, which in turns allows higher position size which will yield more profits but at the same time minimizing the losses.
  2. High Reward: Entering as close as possible to the market turning price will give you the possibility to catch the majority of the move.
  3. High Probability: Proper timing will give you the possibility to know quite fast if your trading idea is good or bad.

Timing the market and identifying in advance market turning points is a function of understanding how smart money operate in the markets. Once you're able to correctly do just that your profitability will increase for sure. Going further with this article we're going to explore a simple and yet so powerful concept that many new traders are not ware of it.

  • The Power of Three

Correctly identifying whether smart money are doing accumulation or distribution in one particular pair comes down to simply looking at the relative strength between the major currency pairs relative to the dollar index. When I'm referring to the "relative strength" I don't mean the indicator but rather which pair between EUR/USD and GBP/USD is stronger or weaker relative to the US dollar.

This type of correlation is one of the strongest concepts you can use as a trader. It can help you find "cracks" in the market and track the SM's actions. It would be foolish not to consult the major market averages to determine the current market tone when trading stocks. This also holds true when trading currencies and the USDX is our reference point.

A rising US Dollar means bearish foreign currency prices while a falling US Dollar means bullish foreign currency prices. When this are not longer respected we have a bullish/bearish divergence which can help us anticipate market turning points.
We see a lower high in the Cable and a lower low in the USDX. When the USDX makes a lower low, we would expect to see a higher high in the Cable which has not happened and is indicative of SM selling GBP/USD. This concept is how you discern intermediate term price swings in the market. This can also be reversed with the green line representing the Cable up, top this time.

Look for buy signals in the Cable if the above image occurs in the market. When trading you want the USDX and currency pairs to confirm each other, otherwise we have a crack in correlation and indicative signs of SM operating in the market. You can also use SM divergence with correlated pairs and not just the USDX. This is called correlated pair divergence. In the image below, the black line is the EUR/USD and the red line is the GBP/USD.

If you are anticipating a support level to be traded to and the Fiber fails to make a lower low into that higher time frame support level while the Cable succeeds to make a lower low into that same level, then that is bullish SM divergence. Look for both of them to trade higher because they are closely correlated. However since EUR/USD is showing relative strength we're better of by focusing on fiber.

You are not only looking for SM divergence to take a trade, you are only using it around predetermined levels with a trade idea in mind, then once the pattern unfolds, that is the green light to get into the trade. To summarize this concept, the correlate pair divergence is a crack in correlation between two closely correlated pairs like EUR/USD and GBP/USD where we have 2 scenarios:
  1. If EUR/USD is making a LL, while GBP/USD is making a HL, this is bullish for the pairs.
  2. If EUR/USD is making a HH, while GBP/USD is making a LH, this is bearish for the pairs.

Keep in mind you'll use this concept in conjunction with key support/resistance level. Unlike the correlated pair divergence, you are here comparing high vs. lows and vice-versa when it comes to SM divergence USDX we have 4 distinct scenarios:
  1. If the USD makes a LL, while the foreign currency makes LH, this is bullish for the USD.
  2. If the USD makes a LH, while the foreign currency makes LL, this is bearish for the USD.
  3. If the USD makes a HL, while the foreign currency makes HH, this is bullish for the USD.
  4. If the USD makes a HH, while the foreign currency makes HL, this is bearish for the USD.

Learn to study price action near key S/R levels on higher time frames and you can "anticipate" the actions of SM. When the USDX and correlated pair SM divergence materialize at a discernible and predetermined support level, we can have confidence that a reaction will unfold. SM moves large flows and by that very fact, their movements have huge footprints. It cannot be hidden from the informed trader.

  • Smart Money Divergence in Action

Since we already outlined the core principles of SM divergence it's time to look at the most recent price action and look at:
  • Who is behind the market moves;
  • How to use USDX to qualify setups;
  • Looking for cracks in correlation between the pairs;
  • How can we detect the move prior to them unfolding;
Earlier April we saw a crack in correlation and SM divergence in the fiber and cable (see Figure 4) which was the starting point of this rally that we saw in both pairs over the recent months and it all started with a crack in correlation. While Cable made a LL it has not been confirmed either by fiber which made a HL and at the same time the dollar index was making LH. Since cable LL has not been confirmed by fiber and DXY we have smart money buying the dollar cross pairs (buy EUR/USD and GBP/USD).
Figure 4: Spotting SM Divergence

Timing the market when using this SM divergence techniques can help you anticipate market reversals because smart money can't hide from you, their movements have huge footprints, just that you have to learn how to read it. In the same above figure we have another major opportunity in Jun, where the move in cable was not confirmed neither by fiber nor by DXY. If the dollar was so weak why couldn't EUR/USD post a HH which should have been complemented with LL in DXY, which never happened.

USDX making HH and the trading pair making LL is normal. However, either the trading pair or USDX can fail to make HH or LL, when we see this is a footprint of smart money moving into the market. You might not see or anticipate a high/low forming in EUR/USD but it will be triggered by the USDX low/high which is a sign of SM operating in the market. The power of this simple tool will make more sense to you as you start practicing and trade alongside SMART MONEY.

Best Regards,
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