A smoothed out version of the Stochastic Oscillator that compares the close not to the high or low like the classic formula, but to the midpoint of price action range.
Overview
Created by William Blau, the Stochastic Momentum Index was described in the January 1993 issue of Technical Analysis of Stocks and Commodities magazine.
The SMI is a smoother version of the classic Stochastic Oscillator with an interesting twist. Instead of calculating the distance the current price relative to the recent n-period high/low range, the SMI is calculated by comparing the price to the midpoint average of the n-period high/low range. The raw price differences are then smoothed by a double EMA (an EMA of an EMA of the raw price differences). When the close is greater than the midpoint of the range, the SMI is positive. When the close is less than the midpoint of the range, it is negative.
The result is an oscillator that ranges between +/- 100 and is less erratic than an equal period Stochastic Oscillator.
The SMI on the EUR/CAD Daily Chart on 3/30/2011
Source: VT Trader
Interpretation
Popular methods for interpreting the Stochastic Momentum Index include:
1. Overbought/Oversold Level Crossovers: +/- 40 are popular levels. Buy when the SMI falls below the oversold and then rises above that level; Sell when the SMI rises above the overbought level and then falls below that level.
2. Signal Line Crossovers: Buy when the SMI rises above its signal line and sell when the SMI falls below the signal line.
3. Divergences: For example, where prices are making a series of new highs and the SMI is failing to surpass its previous highs.
