The Stochastic Momentum Index (SMI) was developed by William Blau and was introduced in the January 1993 issue of Technical Analysis of Stocks & Commodities magazine.
It incorporates an interesting twist on the popular Stochastic Oscillator. While the Stochastic Oscillator provides you with a value showing the distance the current close is relative to the recent x-period high/low range, the SMI shows you where the close is relative to the midpoint of the recent x-period high/low range.
The result is an oscillator that ranges between +/- 100 and is a bit less erratic than an equal period Stochastic Oscillator.
The interpretation of the SMI is virtually identical to the Stochastic Oscillator.
Three popular methods include:
Buy when the SMI falls below a specific level (e.g., -40) and then rises above that level, and sell when the Oscillator rises above a specific level (e.g., +40) and then falls below that level.
However, before basing any trade off of strict overbought/oversold levels it is recommended that you first qualify the trendiness of the market using indicators such as r-squared or Chande Momentum Oscillator. If these indicators suggest a non-trending market, then trades based on strict overbought/oversold levels should produce the best results. If a trending market is suggested, then you can use the oscillator to enter trades in the direction of the trend.
Buy when the SMI rises above its signal line (dotted) line and sell when the SMI falls below the signal line.
Look for divergences. For example, where prices are making a series of new highs and the SMI is failing to surpass its previous highs.
Mr. Blau also notes that a 1-day SMI (with large smoothing periods such as 100) is very sensitive to the close relative to the high and low of the day.