Momentum traders rely on technical indicators to measure the dynamics of price activity based on a particular level of an asset. Their approach is opposite to that of a long-term investor in the sense that a dynamic trader wants to trade with a trend. As the asset price grows, the trader buys it and hopes to benefit from the price increase in the short term. Because trends can evolve rapidly, success depends on investment dynamics analyzed through a combination of technical indicators.
One such indicator is the Stochastic Oscillator. It is a momentum indicator that calculates the current close price of an asset and compares it to the moving average of that asset over a selected period. Traders use the information provided by the oscillator to capture short-term buy or sell signals that give them the entry and exit points of the positions.
However, the limitation of stochastic oscillators is that they can be intermittent, which means that they can be sensitive to price fluctuations, especially during short periods. Investors can compensate for the oscillator by extending the period (called data smoothing). But another way is to use the Stochastic Moment Index (SMI). SMI is a relatively new trading tool when compared to some of its more established counterpart. The SMI has been around since 1993 and is usually available as an additional indicator to download and install on your trading platform.
What is the Stochastic Moment Index?
The Stochastic Moment Index (SMI) is a momentum indicator for financial instruments. The Stochastic Moment Index can be utilized in technical analysis as an alternative to the traditional stochastic oscillator. SMI is a calculation of the distance from the current close price of an asset concerning the high and low-price range. This is visually reflected in the chart, usually with an exponential moving average (EMA). Technical indicators such as the SMI and its predecessor, the stochastic oscillator, are used to invest in momentum based on the theory that the asset rises as high as the market grows.
In contrast, the asset is closed at a low level when the market is on a trend at a lower level. Because the pace of investors to “trade with the trend” is an indication that the SMI is particularly useful. William Blau developed the Stochastic Moment Index in 1993 in response to an attempt to further enhance traditional stochastic oscillators.
What are the benefits of the Stochastic Moment Index?
- Predictability – Most technical analysts believe that SMI is less unpredictable than a traditional stochastic oscillator over the same period.
- Advanced alert – Momentum traders are looking for early signs of possible trend changes at critical levels. SMI gives them an advanced alert of possible changes so they can schedule their movements with precise entry and exit points.
- Fewer guesses – The combination of predictability and advanced communication makes SMI a better indicator to establish the entry and exit points with least guess work.
What are the disadvantages of the Stochastic Moment Index?
- Does not predict a trend – SMI shows the time of day, and although it is very accurate in predicting extreme short positions, it is not an excellent indicator to further predict the direction.
- Requires using other indicators – To gain a better understanding of the direction of the trend, the SMI should be analyzed with other trend indicators such as the R-square indicator.
- No trading signals are generated in the trend market – other oscillators should be used with SMI to show the direction of the trend.
Components of the Stochastic Moment Index
The two components of SMI are line % K and % D. Let us examine each of these elements separately.
Line% K – this is the mainline of the SMI and reflects the measured period. It is usually shown below the stock chart with a solid line.
Line% D is a simple moving average of% K. a dashed line usually represents it. This moving average is based on the calculation of the number of periods specified.
The Stochastic Momentum Index indicator is linked between 100 and -100. A positive reading indicates that the current final price is above the median of the highest / lowest range. When the number is greater than 40, this usually shows an upward trend. A negative reading indicates that the current final price is below the median of the highest / low range. When the figure stays below -40, it usually means bearishness.
How to use the Stochastic Moment Index?
The Stochastic Momentum Index (SMI) provides three standard trading signals:
- Overbought/oversold areas – as mentioned above, SMI is fixed in the range of -100 to 100. When the line value % K is more than +40, this is generally considered a safety sign, and the trend is changing. However, when the value of the % K sequence is less than -40, it usually indicates that the asset has been oversold, and the trend is moving upwards. It is always important to emphasize what SMI looks like with clear support and resistance. Otherwise, you can stop trading against the trend.
- Crossover of the signal line – The color mark indicates when the line% K exceeds the line% D (or moving average). When the% K line rises above the average moving mark, it is considered a buy entry. When the% K line is below the moving average, it is regarded as a sell entry. This approach can result in lower profit margins for traders. However, they can increase the chances of profitable trades by adding a “neutral zone”. This usually happens between +/- 15 points. The idea is that the traders will not trade at any cross-section of this mark, but will use it as a benchmark to track the response in the support or resistance market. If the trend is confirmed, there may be an increase in volume, or traders may add more positions.
- The SMI divergence is the least common indicator, but it can be a beneficial trading signal once it is found. When currency prices approach the highs, but the SMI is not, it can give the opposite sign when the price falls to relative support. However, if the price closes at a low level, but SMI does not, it is considered an increasing spread and will give the opposite trade call when the price breaks the relative resistance.
Stochastic Moment Index trading strategy
Here’s a simple trading strategy based on SMI:
Stochastic Moment Index buy setup
- You can buy an asset if the SMI is near -100 and the price starts rising.
- The stop-loss can be placed slightly below the local low.
- You can exit either on the immediate resistance level or you may wait for the SMI to reach near overbought zone.
Stochastic Moment Index sell setup
- You can sell an asset if the SMI is near +100 and the price starts rising.
- The stop-loss can be placed slightly above the local high.
- You can exit either on the immediate support level or you may wait for the SMI to reach near oversold zone.
Stochastic Moment Index conclusion
The Stochastic Moment Index can be used to compensate for some of the capacities of a conventional stochastic oscillator by calculating the center of the highest and lowest range of securities and displaying traders where the closing price is relative to that center.
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