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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 2
C = (HMAX + LMIN)/2
Now subtract this C from the current close (CC) to get D, the "distance:
D = CCC
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 reversal
Common trading level: Overbought (bullish) above +40 / Oversold (bearish) below -40
Basic turning point signals:
Buy when the indicator rises above -40 from below
Sell when the indicator moves below +40 from above
Cross-over 1: SMI passes moving average from below = Buy
Cross-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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sized 1157x720.
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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sized 1152x720.
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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sized 1152x720.
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
Have any comments or questions to help us learn? Share them in the section below.
Attached Thumbnails
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.