/ TERMS & FAQS

# Stochastic Momentum Index: A Better Stochastic

The stochastic momentum index (SMI) is a technical analysis indicator that shows price momentum by calculating its closing price distance relative to its median high-low price range. The SMI attempts to improve upon the traditional stochastic oscillator.

### Key Takeaways

• The stochastic momentum index (SMI) is an upgraded version of the traditional stochastic oscillator.
• It helps in determining the momentum of price in any given market condition.
• Traders view the SMI as a more reliable indicator for determining entries and exits through crosses, divergence, and overbought and oversold levels.

## What Is the Stochastic Momentum Index?

The stochastic momentum index (SMI) is a technical analysis tool that analyzes price momentum. It’s calculated using the closing price relative to the median range (high-low) of the security’s price over a specified period.

The indicator is represented on a chart as an oscillator, not to be confused with the stochastic oscillator, as seen in the image below:

Traders familiar with the stochastic oscillator will quickly notice the stochastic momentum indicator responds quicker to price.

## What Does the Stochastic Momentum Index Tell You?

Developed by William Blau in 1993, this stochastic tool is an upgraded indicator that shows the directional momentum in any given market, based on an asset’s closing price.

It helps you determine potential overbought and oversold levels on a chart, and it also helps assess trade direction.

It’s crucial to know how to effectively interpret the buy and sell trade signals generated by this indicator, including overbought/oversold conditions, signaling crossovers, and divergence.

Here’s what the stochastic momentum index tells you:

• Overbought or Oversold: Like the stochastic oscillator, traders use this indicator to identify potential overbought and oversold conditions.
• Momentum: The SMI can also be used with volume indicators to show how much buying or selling pressure the momentum carries.
• Trend: Some traders use the stochastic momentum indicator as a general trend indicator to determine bullish and bearish price movements in the market.
• False Trend: The SMI can also show divergences, indicating a false trend, or the end of an existing one.

## How Does the Stochastic Momentum Index Work?

The SMI displays an oscillator, the stochastic momentum oscillator, that is ra.

The indicator normalizes the price of an asset as a percentage between the two extreme values. Typically, two lines are plotted, the %K line, (the blue line in the chart below) and a moving average of the %K, known as the %D (the red line).

The raw %K value is also known as the fast stochastic, while the %D value is known as the slow-moving stochastic or the “signal line”.

When the two indicator lines show elevated values (+/-40), it indicates a strong trend leading to potential overbought or oversold market conditions.

The arrow at the bottom indicates potentially oversold conditions in the chart below, which translates to a buy signal. In contrast, the arrow at the top shows a selling opportunity with potentially overbought conditions.

## Stochastic Momentum Index Calculation

The formula for the stochastic momentum index can be calculated as follows:

$SMI(price,q,r,s,u) =$ $\frac{100*EMA(EMA(EMA(price-1/2*[LL(q)+HH(q)] ,r),s),u)}{EMA(EMA( 1/2*[HH(q)-LL(q)], r)s)u} =$ $\frac{100 * SM(price, q,r,s,u)}{EMA(EMA(EMA( 1/2*[HH(q)-LL(q)],r),s),u)}$

Where:

• price - close price;
• LL(q) - minimal price (q bars);
• HH(q) - maximal price (q bars);
• sm(price,q)=price-1/2*[LL(q)+HH(q)] - q-period Stochastic Momentum;
• SM(price,q,r,s,u) - triple smoothed q-period Stochastic Momentum;
• HH(q)-LL(q) - q-period price range;
• 1/2*[LL(q)+HH(q)] - midpoint of q-period price range;
• 1/2*[HH(q)-LL(q)] - half of q-period price range;
• EMA(…,r) - 1st smoothing- exponentially smoothed moving average with period r, applied to:
• to the Stochastic Momentum;
• to the half of q-period price range;
• EMA(EMA(…,r),s) - 2nd smoothing - EMA of period s, applied to result of the 1st smoothing;
• EMA(EMA(EMA(…,r),s),u) - 3rd smoothing - EMA of period u, applied to result of the 2nd smoothing.

Input parameters:

• q - period, used for the calculation of Stochastic Momentum (by default q=5);
• r - period of the 1st EMA, applied to stochastic (by default r=20);
• s - period of the 2nd EMA, applied to result of the 1st smoothing (by default s=5);
• u - period of the 3rd EMA, applied to result of the 2nd smoothing (by default u=3);
• AppliedPrice - price type (by default AppliedPrice=PRICE_CLOSE).

Note:

• q>0;
• r>0, s>0, u>0. If r, s or u =1, smoothing is not used;
• Min. rates=(q-1+r+s+u-3+1).

## Stochastic Momentum Index Excel Formula

The VBA code does a lot of the heavy lifting for calculations such as these, but worksheet formulas can also be used to calculate the SMI in Excel.

However, it’s essential to keep in mind that although simple to use, these are a lot less flexible than VBA.

Read this article if you would like to know more about calculating the stochastic momentum index in Excel. It goes into more detail on the process of using worksheet formulas.

## Best Stochastic Momentum Index Settings

The SMI is often called an overbought and oversold indicator. It has two lines that we should focus on: %K, and %D.

• %K = 5. It’s the faster line that represents the main movement of price.
• %D = 3. It’s a slower line, a simple moving average (SMA) of the % K.

Most traders stick to the default settings when looking for trading opportunities using the stochastic momentum index; however, the SMI is a lot faster than the traditional stochastic oscillator, which means some traders may want to increase the %K line periods across which the SMI is reading in order to slow down the indicator. Traders typically don’t increase the slower moving average line as it reduces the speed of the signal.

## Stochastic Momentum Index vs. Stochastic Oscillator

The stochastic oscillator and the stochastic momentum index attempt to determine momentum in any market condition. Although similar, the stochastic indicator and the stochastic momentum index have distinct differences that make them ideal for different trading styles.

A traditional stochastic indicator is a more straightforward tool that only shows the directional momentum based on the security’s current closing price at the end of the period being measured (months, days, intraday, etc.)

The stochastic oscillator compares the close prices of particular security with the highest and lowest prices, the high low range, over a specific period. However, traders often come across problems due to the stochastic oscillator price sensitivity to closing price causing price fluctuations, leaving some traders looking for solutions.

Changing the bar period is one way to smooth the fluctuation level in the stochastic oscillator. Another method to smooth out signals is by changing the overall period or the %D in the stochastic oscillator settings.

Alternatively, some momentum traders drop the stochastic oscillator in favor of the stochastic momentum index.

It incorporates the distance of the security’s closing price relative to the high low range’s median, giving momentum traders a smoother ride view of the asset’s price closed relative to the recent range.

Because of this, traders consider the SMI a better predictor of turning points.

## What Are the Advantages of the SMI?

• Ease of Use: The SMI helps momentum traders identify shifts in price momentum.
• Momentum-based: The SMI is a momentum-based indicator, which is said to lead price action.
• Clear Signals: Shows signs of possible shifts in momentum for mean reversion or trend reversal trades.

## What Are the Disadvantages of SMI?

Must Be Used with Volume Indicators to Confirm Momentum: For traders to get a better sense of where the market is headed, they need to use the SMI together with indicators that measure volume in the market.

## How To Use the Stochastic Momentum Index

For the most part, traders depend on technical analysis tools like the SMI to determine the price momentum and direction of a particular security to go long or use it as a sell signal to go short.

There are many ways to trade using this indicator. Below we take a look at three primary ways you can use the SMI in your trading:

• Overbought and Oversold
• Signal Line Crossover
• Divergence

### Overbought and Oversold

The SMI can be a powerful technical analysis tool that helps you find potential overbought and oversold market levels.

However, if there are no clear support or resistance areas, it can be dangerous to blindly trade overbought and oversold signals generated by the SMI.

But, in clearly ranging markets, traders can use the +/-40 levels on the oscillator to find potentially profitable trading opportunities.

It’s important to note that +40 or -40 oscillator levels show strong trends, and it’s possible for the trend to continue, but the idea is a strong price movement turns into profit-taking, which causes a trend reversal.

### Crosses

The signal line crossover is arguably the easiest use of this indicator. To find buy and sell signals, all traders have to do is simply watch the relationship between the two lines %K (k line) and %D (d line).

This trading method presents a huge number of potential trades, which results in a lower win percentage (that is, the number of trades that are profitable, divided by the total number of trades).

But, there are methods you can use to filter out lower probability SMI crossover trades. One such method is to add a neutral zone in the oscillator area at the levels of +/-15.

By making use of this neutral zone, you make it more likely that you will be able to stay in profitable trades longer and not take actions near the zero line.

How you view this neutral area is filtered in the most recent trend.

So, for example, if you enter a sell trade based on a crossover at +40 or more, and then you see a crossover within the +/-15 neutral zone, you wouldn’t reverse the position immediately, but rather watch and see how the market is going to react to relative support on the move lower.

If the price happens to move smoothly through the neutral zone, and the trend stays intact, then you can simply tighten your stops, or even add to your trade, depending on your particular trading methodology.

The image below shows an example of a stochastic momentum oscillator crossover:

### Divergence

SMI divergence can happen on overbought or oversold areas of the chart. Although divergence isn’t widespread, it’s still a potential trading signal.

SMI divergence occurs when the price makes higher highs (or lower lows, as the case may be), but the oscillator does not follow suit.

Because momentum leads price, you should trade with the indicator and not price momvement expecting a trend reversal using support and resistances as your guide.

The image below is an example of SMI divergence:

Just remember that with all the different ways you can use the stochastic momentum indicator, it’s never wise to take overbought/oversold, crosses, or divergence trades without any confirmation from other technical analysis tools. Additionally, you should backtest everything.

• Scalping;
• Order flow analysis.

Daytrading, on the other hand, involves opening a position in any given market only to exit at the closing bell.

While this strategy does hold some similarities to the intraday approach, day traders typically don’t deal in high volumes, but rather they tend to identify a premium opportunity early on in the trading day so they can then execute that opportunity on a session by session basis.

Some strategies for day trading include:

Whichever approach you take, you can use the SMI to help you find potentially profitable trading opportunities in the market.

The SMI can be used effectively for intraday and day trading when there is a clear range in the market. The tool works to provide entry and exit signals in the same way it would for longer time frames.

## Setting Up the Stochastic Momentum Index in TradingView

To set up the SMI indicator in TradingView, simply go to the “Indicators” tab, and search for stochastic momentum index.

Once you locate it, click on it, and it will be automatically installed on your charts. By default, the % K length is set at 5, while the % D length is set it’s 3.

If you click on “Settings”, you will be able to see the different inputs and styles you can choose from to tweak your indicator according to your preferences and trading style.

Most traders use the default settings for the stochastic momentum index, and, as previously mentioned, there’s a bit of a learning curve before traders can understand how to tweak the indicator settings effectively to match their trading style.

## Conclusion

The SMI is a popular momentum indicator that exposes you to multiple methods of determining entries and exits in the market.

Whether you use it for taking trades off of overbought/oversold areas, simple SMI divergence, or signal line crossovers, adding the SMI indicator to your trading arsenal will help you spot more trading opportunities that aren’t easily seen using price action alone.

What’s your experience been like using the stochastic momentum index? Share your thoughts in the comments below!

#### Leo Smigel

Based in Pittsburgh, Analyzing Alpha is a blog by Leo Smigel exploring what works in the markets.