The SMC Forex trading strategy is the latest approach to the price action strategy. Smart money concepts trading as it is called, uses replacements for legacy terminology such as supply and demand, support and resistance and price patterns.
Its concept is that institutional investors, central banks, hedge funds and market makers manipulate financial markets to the detriment of retail traders. The concept says that retail traders should follow the trades of these institutions instead of trading against them.
What is Forex trading?
First of all, let’s cover the basics of the market structure that SMC seeks to trade; FX. Forex or the Foreign Exchange market, is one of the largest, most active and most liquid in the world.
Traders open positions on currency pairs, placing sell orders or long orders depending on the general market trend at the moment of the trade.
When analysing the markets and trading Forex, traders look for trading patterns that forecast price action, such as price drops or reversals. Traders often use graphic interpretations of mathematical calculations to forecast these rate movements, known as indicators, to confirm their forecasts or to glean further information about market sentiment, volume, the current trend, or even levels where breakouts may happen.
In very simple terms, when the rate of a currency pair drops, a trader will go “short” or sell the currency pair, and close the trade at a lower price. Whereas if the price rises, they will try to buy it at the lowest price possible and sell it at a higher price. There are other levels that help market participants set stop out to protect their profits and accounts.
Smart Money Concepts (SMC) defined
Supply and demand are among the most universally accepted principles of the speculative markets. SMC concepts add one more variable through manipulative entities such as banks.
SMC traders should base their strategies on the funds controlled by these aforementioned entities or follow the “smart money” which includes professional traders, banks and other market makers.
To do so, SMC changes some of the common terminology used and adjusts certain trading techniques to accommodate this theory. It still uses most of the tools, chart patterns and signals as the price action trading strategy, so if you are familiar, once you understand the terminology, the strategy should be easy to implement.
Smart money concepts trading involves looking at order blocks, which is a more refined version of supply and demand, breaker blocks, mitigation blocks, flip zones, fair value gaps and liquidity grabs.
These terms replace support and resistance, reversals and volume.
The origin of SMC
The originator of SMC Forex trading is said to be The Inner Circle Trader, a trader named Michael J. Huddleston, but the concept has found many fans on various Forex forums.
Key components of SMC
Here are some of the key parts of the smart money theory.
Order block:
The order block is simply a replacement for the supply or demand an asset experiences.
Breaker or mitigation blocks:
This is what is traditionally called support and resistance.
Fair value gaps:
These are imbalances on the market, i.e. when demand outpaces supply or vice versa.
Another important concept of SMC is what is called a break of structure or BOS. This is when the chart breaks past previously established lows or breaks above a previous high.
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Why SMC is important in Forex trading
Smart money trading uses some of the most effective and time-tested techniques to gain valuable insights. Retail traders have been using price action technical analysis for decades, and ultimately no matter the terminology SMC uses, it is essentially a one in the same.
Of course, smart money trading adds market structure and trade decisions based on investors, banks, other power players on the markets, hedge funds and market makers.
Even with the new terminology SMC concepts use, it is vastly popular because it might be more user-friendly and easier to comprehend when trading Forex compared to the legacy version of the strategy.
Risk management
A retail trader and an SMC trader will often use the same risk management strategies. This includes using limit orders to avoid runaway losses or reversals, not overtrading and having a reasonable risk-to-reward ratio.
Profit maximisation
When the balance between supply and demand is reversed, then you will see assets value and trend change. This can be confirmed by liquidity, as smart money refers to trading volume. This can be discerned by a technical analysis indicator like RSI or MAs.
How SMC works
First, let’s consider the item that SMC focuses on – banks and the structures set up for success when on the markets.
These huge players will place large orders, that may not directly affect liquidity, but the subsequent market sentiment will.
Fair value gaps are one of the areas where smart money trading takes place, as it assumes that if assets are trading above or below their fair market value, this is financial market manipulation.
SMC traders or retail traders follow these smart money investments, by researching market sentiment and even future currency contracts (when public).
This helps retail traders position themselves for optimised profit-taking.
Identifying Smart Money moves
As mentioned above SMC traders use both chart illustrating breaks, order blocks and liquidity to confirm the movements when SMC trading.
Market entry and exit points
SMC traders will usually wait for a break of structure or a change of character pattern to act on a price movement. Just to reiterate a break of structure is when price breaks above a previous high, and a change of character is when the price breaks below a previous low and establishes a new low.
Implementing SMC: a step-by-step guide
There are a few steps involved when you are SMC trading, luckily there are free resources (like this one) to help you apply this strategy. This is a universal rule no matter your strategy or method – thorough research is an absolute must.
- Analysis to discern the current order blocks
- Look at the trading liquidity (volume)
- Keep an eye on the price charts to see if the market is creating the conditions for a BOS or ChoCh.
Setting up trading charts
Setting up charts manually can be complex, but there are various ready-made solutions that can help you plot out the critical levels and identify emerging trends and patterns.
Choosing a Forex broker
Choosing a Forex broker with good conditions is another must when trading. Low fees mean your trading session will close with more profit, while fast execution will translate to not being blocked out when markets are at their most active.
Executing trades
In SMC trading, the targets are the same as many other trading strategies. Breakouts, reversals and continuation patterns are all good opportunities to open positions, with the appropriate risk measures.
Common mistakes to avoid
Misidentification of signals is one of the biggest and most common mistakes SMC traders make. A trade that is intended to seize profits from an ongoing trend, but the trend ends up in reversal, can result in significant losses.
Another mistake many traders make has to do with psychology: either entering an unconfirmed trend or exiting a potentially profitable trade due to a small down turn. Overleveraging positions can also have negative results.
Overleveraging
As mentioned above overleveraging can have significant negative results when trading as it multiplies your position and amplifies market movements, which includes both beneficial and negative ones.
Ignoring market news
This is, unfortunately, a drawback of all technical analyses. Because they are based on past data, traders might be “tricked” into ignoring current market conditions or upcoming news. The more information you have available, the better your chance of profiting.
Conclusion
SMC is a valid strategy based on a time-tested and widely-used strategy. It compares favourably to other strategies, such as swing trading and scalping, although each are much more appropriate in a short term timeframe.
If you are looking for the latest and greatest strategy traders are raving about, then SMC might be a great fit for you.
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