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We periodically show the smart/dumb money confidence spread in our Sunday
advisory. Below is an example smart/dumb money spread (blue chart),
courtesy of sentimentrader.com, where it shows that about 79% of the dumb money
believes in the rally, but only 33% of the smart money (i.e. institutional money
managers) believe in the rally.
Taking a look at this indicator more closely to judge its effectiveness we back test 5 years and
mark the extremes
of the smart/dumb confidence spread (bottom blue chart) and how it
correlates to the S&P 500 index. We can see that when the confidence spread triggers at +0.25 or -0.25 it offers reasonable prediction
of either a pull-back or rally, respectively. However, during the
market turmoil and crash in late 2008 through most of 2009 this indicator
was less effective and was difficult to read.
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