Stochastic Oscillator vs. Stochastic Momentum Index: An Overview

The Stochastic Oscillator and the Stochastic Momentum Index, or SMI, are both tools used to indicate momentum, and are often used by financial traders to understand psychological undercurrents and their relation to price movements. Although the two tools are not surefire ways to determine price direction, they can offer key insights into public opinion regarding a stock, ETF, or sector.

Almost all traders use at least one of the tools, but they differ in that the oscillator is a simpler tool and considers the closing price of a given period, such as a day or week. In contrast, the SMI uses more values, producing a median of the high/low range of price movement.

Stochastic Oscillator

The stochastic oscillator is a technical indicator of momentum used to compare closing price to a range of price over a given period of time. This oscillator is sensitive to fluctuations in market price, although the level of fluctuation in the indicator can be smoothed somewhat by altering the time period being measured.

Financial traders use both the Stochastic Oscillator and Stochastic Momentum Index, or SMI, to gauge market momentum.

The theory behind the stochastic oscillator is fairly basic: The price of a security closes at its high in a market with an uptrend, and similarly, closes at its low in a market with a downtrend.

Stochastic Momentum Index

The Stochastic Momentum Index, or SMI, is a more refined version of the stochastic oscillator, employing a wider range of values and having a higher sensitivity to closing prices.

The SMI is considered a refinement of the stochastic oscillator. It calculates the distance of the current closing price as it relates to the median of the high/low range of price. William Blau developed the SMI in an attempt to provide a more reliable indicator, less subject to false swings.

The SMI has a normal range of values between +100 and -100. When the present closing price is higher than the median, or midpoint value of the high/low range, the resulting value is positive. When the current closing price is lower than that of the midpoint of the high/low range, the SMI has a negative value.

Like the stochastic oscillator, the SMI is primarily used by traders or analysts to indicate overbought or oversold conditions in a market. It is used with volume indicators to show if the momentum carries significant selling or buying pressure. Traders also use the SMI as a general trend indicator, interpreting values above 40 as indicative of a bullish trend and negative values greater than -40 as showing a bearish trend.

Key Takeaways

  • Both Stochastic tools are used to determine momentum in any given market condition.
  • The Stochastic Oscillator is a simpler tool, and shows directional momentum based on the closing price.
  • The Stochastic Momentum Index, or SMI, shows the closing momentum and its relation to the median high/low range for that time period.