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Inner Circle Trader (ICT) explored financial markets from different angles. He emphasized on movement of financial assets in correlation. He combined Smart Money Techniques and divergence analysis to identify potential market reversal. This helps in establishing directional bias in trading.
This article explores understanding of SMT Divergence, positive and negative correlation in financial assets, characteristics of SMT Divergence, types of SMT divergence, and trading with ICT SMT Divergence.
Understanding of ICT SMT Divergence
ICT trading concepts explores different scenarios where market behaves differently. ICT SMT Divergence is a unique market behavior where two positively correlated financial assets forms its structural movements oppositely. Normally, correlated assets move symmetrically. This means that if one financial asset makes a higher high, the other correlated asset also makes the higher high. SMT Divergence occurs when this correlation breaks down.
Consider an example of EUR/USD and GBP/USD. Both assets are positively correlated in nature. In strong uptrend, both pairs are expected to form higher highs. If EUR/USD makes a higher high but GBP/USD doesn’t, this difference of structure creates a divergence. These divergences are considered as important because they can signal institutional activity in market.
Like other ICT tools and techniques, SMT Divergence forms in both Bullish and Bearish market. A bullish SMT Divergence occurs when one asset makes a lower low while the other one fails. This suggests accumulation and weak selling pressure. On the other hand, a bearish SMT Divergence occurs when one asset makes a higher high while the other one fails. This indicates weak bullish momentum.
Components of ICT SMT Divergence
There are three things that can be found in SMT Divergence. First, the assets must be correlated. Second, there is a divergence in assets. Lastly, there is a clearly visible institutional activity.
Normally, market moves symmetrically. Correlated assets are those financial instruments that typically moves together due to market dynamics, like EUR/USD, GBP/USD. SMT divergence occurs when assets are positively correlated but does not behave in the same way. This happens when one financial asset show strength while other show weakness.
The second important thing is divergence analysis. When two positively correlated assets behave differently from their usual price relationship, it indicates divergence. For example, if asset A makes a higher high, but asset B makes a lower high. This divergence indicates potential reversal in the market.
Inner Circle Trader believe that institutional traders leave “footprints” when they manipulate prices. These divergences help us to locate institutional activity. Smart Money “footprints” can be seen in how divergences occur at key levels (e.g., liquidity zones and order blocks).
Asset Correlation in Financial Markets
Correlation between financial assets measure their price movement relative to each other. This correlation can be positive or negative. This relationship is important for traders because it helps in uncovering opportunities and manage risk efficiently.
Positive correlation occurs when two assets move in the same direction. This means that when price of an asset increase, the price of its correlated asset tends to rise as well. In forex market, it can be seen between EUR and GBP. Other major currency pairs with similar drivers often present positive correlation due to shared economic influences like interest rates or market sentiment. In crypto market, Bitcoin and Ethereum often show a strong positive correlation. In indices, ES (S&P 500) and Nasdaq 100 typically move symmetrically and reflect the broader market trend in the U.S. economy.
Negative correlation occurs when two assets move in opposite direction. This means that when price of an asset rises, the price of its correlated asset falls. Like, in Forex Market, the US Dollar Index (DXY) and EUR/USD often presents inverse relationship. Understanding these concepts gives an edge in the market.
Bullish SMT Divergence
In ICT Trading, Bullish SMT Divergence when symmetrical movement of two positively correlated assets breaks. This is considered as a potential signal of market reversal or bullish momentum.
Normally, positively correlated assets move in the same direction. During downtrend movement of market, a discrepancy occurs when one of the asset forms lower low and the other asset forms a higher low. This is known as Bullish SMT Divergence because it indicates reversal to the upside.
In ICT trading, we analyze market behavior and dig out institutional footprint. ICT bullish SMT Divergence indicates that “Smart Money” or institutional traders may be stepping to accumulate positions in the asset. This gives us an edge in finding accurate and logical entries in the market.
Now look at the example, NZD and AUD are two positively correlated pairs. In downtrend both pairs are expected form lower low. NZD forms a lower low but AUD forms a higher low. This divergence suggests weak bearish momentum. The higher low indicate that smart money is positioning for a potential reversal to the upside.
This is not just limited to other forex correlated pairs. In the crypto market, a similar situation might occur between Bitcoin and Ethereum.
As far as trading using Bullish SMT divergence is concerned, other SMC and ICT tools and techniques are used to strengthen trade setup. Bullish divergence near key levels like liquidity pools, order blocks or demand zones helps in building confidence. It must be confirmed with major structural break like Break of Structure (BOS) or Change of Character (CHOCH). This confirms trend shift from bearish to bullish.
Bearish SMT Divergence
In ICT Trading, Bearish SMT Divergence when symmetrical movement of two positively correlated assets breaks. This is considered as a potential signal of market reversal or bearish momentum.
Normally, positively correlated assets move in the same direction. During an uptrend movement of the market, a discrepancy occurs when one of the asset forms higher high and the other asset forms a lower high. This is known as Bearish SMT Divergence because it indicates reversal to the downside.
In ICT trading, we analyze market behavior and dig out institutional footprint. ICT bearish SMT Divergence indicates that “Smart Money” or institutional traders may be stepping to sell. This gives us an edge in finding accurate and logical entries in the market.
Now look at the example, GBP and EUR are two positively correlated pairs. In uptrend, both pairs are expected form higher high. GBP forms a higher high but EUR forms a lower high. This divergence suggests weak bullish momentum. The higher low indicate that smart money is positioning for a potential reversal to the downside.
This is not just limited to other forex correlated pairs. In the crypto market, a similar situation might occur between Bitcoin and Ethereum.
As far as trading using Bearish SMT divergence is concerned, other SMC and ICT tools and techniques are used to strengthen trade setup. Bearish divergence near key levels like liquidity pools, order blocks or demand zones helps in building confidence. It must be confirmed with major structural break like Break of Structure (BOS) or Change of Character (CHOCH). This confirms trend shift from bullish to bearish.
Final note
Like other ICT tools, SMT divergence is a powerful tool. This tool helps in identifying market reversals and confirm trade entries. However, this tool is not designed to use alone in ICT Trading. For better results, it must be combined with higher timeframe PD Array. Remember, like any other ICT or SMC technique, it can deliver negative results, but its overall the strategy gives much better results.
Remember, trading with SMT Divergence does not guarantee success in trading. Trading carries risk and may not be suitable for all investors. Past performance does not guarantee future results. Use proper risk management strategies and do not trade with funds that you cannot afford to lose.
Frequently Asked Question (FAQs)
What is an ICT SMT Divergence?
ICT SMT Divergence, introduced by Inner Circle Trader, is a concept used to find reversal in correlated assets. In SMT Divergence, two positively correlated assets deviate from their typical symmetrical price movement. This deviation presents a potential market reversal caused by institutional manipulation.
How SMT Divergence indicate a reversal?
Normally, correlated assets develop same structure. However, in SMT Divergence, one asset makes higher high but the other one fails to do so. This suggest that the high is likely a trap for retail traders. Such divergence reflects underlying market weakness and signal a potential reversal.
Is SMT divergence applicable across all markets?
Yes, SMT divergence can be applied in forex, indices, cryptocurrencies, and even commodities, provided the assets being compared are positively correlated.
Which timeframes are best for SMT Divergence?
Higher timeframes like H4, daily, or weekly provide stronger signals. Confirmations can be taken from lower timeframes like M15 or M5.
I’m Aatiq Shah, a dedicated forex and crypto market practitioner with three years of hands-on experience. Currently, I’m working as a Financial Manager. My journey in the world of finance has equipped me with the skills and knowledge needed to navigate the complexities of the forex and crypto markets.
