What is stochastic momentum index?

The Stochastic Momentum Index (SMI) is a technical indicator used in technical analysis of financial markets. It was developed by William Blau and presented in the book "Momentum, Direction and Divergence" in 1995. The SMI is an oscillator that measures the distance between the current closing price and the midpoint of a previous closing range.

The SMI is based on the Stochastic Oscillator, which measures the level of a stock or asset's closing price relative to its price range over a given period. However, unlike the Stochastic Oscillator, the SMI takes into account a different period, known as the moving average period, which smoothens the calculation.

The calculation of the SMI involves three components:

1. Price difference: The difference between the current closing price and the midpoint of a previous closing range.
2. Lookback period: The number of periods used to calculate the moving average of the price difference.
3. Moving average period: The number of periods used to calculate the moving average of the lookback period.

The SMI ranges from -100 to +100, with values above zero considered bullish and values below zero considered bearish. Traders and investors use the SMI to identify overbought and oversold levels, determine potential trend reversals, and generate trading signals.

Some common interpretations of the SMI include:

1. Overbought/Oversold conditions: When the SMI reaches or crosses above +40, it is considered overbought, indicating a potential reversal or pullback. Conversely, when the SMI reaches or crosses below -40, it is considered oversold, indicating a possible upward price movement.
2. Divergence: When the price of an asset makes a new high or low, but the SMI fails to follow suit, it can signal a potential reversal in the price trend.
3. Signal line crossover: Some traders use a signal line (often a 9-period moving average of the SMI) to generate buy or sell signals when it crosses above or below the SMI line.

It's important to note that the SMI, like any technical indicator, is not infallible and should be used in conjunction with other analysis techniques and indicators to make informed trading decisions.