KEY POINTS REGARDING THE STOCHASTIC MOMENTUM INDEX

Introduced by William Blau in 1993 as a faster, less erratic version of the traditional stochastic oscillator

Evaluates the Current Close relative to the midpoint of the Recent High/Low Range instead of simply the High and Low, and graphs this value along with a moving average (Stochastic %D)

Helps predict turning points and duration of current price move

Best used alongside a way to predict trendiness of market (like Chande Momentum Oscillator or R-Squared); like other oscillators, the indicator calculates the direction of an emerging trend, but does not generate reliable signals in a trending market

CALCULATING THE STOCHASTIC MOMENTUM INDEX

First select a period N; then, determine the center (C) of the range during this period by adding the highest high and lowest low within the period and dividing the sum by 2C = (HMAX + LMIN)/2

Now subtract this C from the current close (CC) to get D, the "distance”:D = CC–C

The indicator smooths the distance value twice (DS1 and DS2) with a 3-period EMA:DS1 = EMA(3)(D)DS2 = EMA(3)(DS1)

Now smooth the difference between HMAX and LMIN twice (DHL and DHL2), using the earlier EMA, and dividing the second result by 2:DHL = EMA(3)(HMAX – LMIN)DHL2 = EMA(3)(DHL)/2

We can now calculate today's SMI value:SMI = 100 * (DS2/DHL2)

READING THE STOCHASTIC MOMENTUM INDEX

An extreme position (approaching -100 or +100) implies the likelihood of a reversalCommon trading level: Overbought (bullish) above +40 / Oversold (bearish) below -40

Basic turning point signals:Buy when the indicator rises above -40 from belowSell when the indicator moves below +40 from aboveCross-over 1: SMI passes moving average from below = BuyCross-over 2: SMI falls below moving average from above = Sell

(Cross-overs that occur between -15 and +15 are often unreliable)

Divergences are uncommon, but can be used to check signals or produce strong signals: Buy for bullish divergence, sell for bearish

EXAMPLES

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In this example of instances of the oversold/buy signal, the indicator has dipped below -40 near the points indicated by the red arrow, with a further buy signal produced by a cross-over indicated with the green arrows

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By contrast, in this example of instances of the overbought/sell signal, the indicator has risen above +40 near the points indicated by the red arrow, with a further sell signal produced by a cross-over indicated with the green arrows

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This final example shows a slight bearish divergence between price and indicator value, reinforcing the sell signal implied by the second peak's breach of the +40 threshold

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Stochastic Momentum Index (SMI)Developed by William Blau in 1993, it is an extension of the Stochastic Oscillator indicator, only calculated slightly different (it regards the mid range instead of the true range of the price per period).

Why should I use it?

The SMI is a smoother version of the Stochastic Oscillator (less erratic and more even in its movement), therefore you can use it in a similar way you use the Stochastic Oscillator- Finding overbought/oversold levels, and using crossovers between the SMI lines as buy and sell signals. Because it is smoother, the SMI is more controlled and in tone with the market, therefore it has a greater chance of filtering out false signals. Try to insert both the Stochastic Oscillator and the SMI on the same chart, it will help you understand the difference between the two.

How does it look like?

The SMI is composed out of two lines.The first is the %K line which is the main line of the indicator, and is also called the signal line.

The second is the %D line which is the dashed line. Notice that the SMI can have any value between 100 and -100, meaning it can get negative values as opposed to the Stochastic Oscillator which can have only positive values.

How does it work?

Two common ways to read the SMI indicator:As an overbought/oversold indicator:The price is oversold when the SMI drops under -40, a buy signal is triggered the next time the SMI move back above -40.The market is overbought when the SMI rise above +40, a sell signal is then triggered the next time the SMI move back below +40Crossover signals:You can also regard the crossing of the solid %K over the dashed %D line as buy or sell signals in the following way:When the solid line (%K) crosses the dashed line (%D) from below upwards it will indicate a buy signal.When the solid line (%K) crosses the dashed line (%D) from above downward it will indicate a sell signal.

Example

In the example below the SMI is providing a good sell signal in two different ways:The first on Nov 23 when the %K line is moving under the %D line indication a sell.The second sell signal was around Dec 7 when the SMI crossed back under the oversold level +40. In this case, following the two sell signals was a sharp drop in the market price.