Stochastic Momentum Index Guide – NewZimbabwe.com
Trading in the stock market can be difficult, especially given the variety of technical indicators accessible to traders. The Stochastic Momentum Index (SMI) is a lesser-known yet extremely powerful indicator.
The stochastic momentum index is a technical indicator that traders use to identify potential buy and sell signals in the market. Instead of reading the asset’s closing price as the standard stochastic indicator, the SMI calculates the closing price based on the high/low range average. Let’s explore this article in detail.
What is Stochastic Momentum Index
The stochastic oscillator is calculated by comparing an asset’s closing price to its price range over a specified period. The price range represents the difference between the highest and lowest prices at the same time.
The stochastic oscillator generates the %K and %D lines. The %K line displays the current closing price as a percentage of the price range for a given time period, usually 14 days. The %D line is a moving average of the %K line, typically calculated as a 3-day simple moving average.
Stochastic Momentum Index Settings
These oscillators are also known as oversold and overbought indicators.
You’ll need to pay attention on two lines %D and %K that are here:
%K is commonly set to 5 and indicates the main changes of price (slow line).
%D is the quick line, a simple moving average of the %K, which is set to 3.
These two lines fluctuate between the values of +100 and -100. The 0 line represents the midpoint of our observation period’s high/low range.
An additional level, +/- 40, is where traders identify a market as overbought or oversold.
+40 is viewed as overbought
-40 is viewed as oversold
You’ll see overline that is green and overload line will be red. When the current closing price plot is more than the average of the high/low, positive you’ll see return on the SMI.
If the current closing plot is less than the average of the high and low, you’ll get a negative return plot.
Trading With the Stochastic Momentum Index
When you use SMI, you’ll use three main trading strategies:
- Oversold and overbought
- Crosses of the lines
- SMI divergence
How to Calculate the Stochastic Momentum Index
There are various methodical steps include in calculating stochastic momentum index. Here are the following steps below:
- Calculate the Median Price
For calculating the median price, this is the average of the highest high and the lowest low over a given period.
Median Price = (Highest High + Lowest Low) / 2
2. Determine the Distance from Median
It’s the methodical step of calculating the distance from median price.
Distance = Closing Price − Median Price
- Calculate the Smoothed Distances
To smooth the data and eliminate noise, use a Simple Moving Average (SMA) on the distance.
Smoothed Distance = SMA (Distance, period)
- Compute the Range of Highs and Lows
Determine the range between the highest high and the lowest low over the same period:
High – Low Range = Highest High − Lowest Low
- Smooth the High-Low Range
Similarly, use the SMA to the high-low range to smooth it:
Smoothed Range = SMA (High – Low Range, period)
- Calculate the SMI
To calculate the preliminary SMI value, use the smoothed distance and range:
SMI = 100 × Smoothed Range / Smoothed Distance
- Smooth the SMI
Finally, smooth the initial SMI value with another SMA to get the final Stochastic Momentum Index.
SMI (final) = SMA (SMI, signal period)
In this way, traders can identify the potential of trading signals.
Conclusion
The Stochastic Momentum Index (SMI) is a useful indicator. It provides the detailed information about market momentum. It also allows traders to better understand price movements and potential turning moments. The SMI enhances the standard stochastic oscillator by giving a more refined and sensitive measure of market momentum.
