Summary:
- The Stochastic Momentum Index (SMI) Ergodic is a leading indicator that sends buy and sell signals by predicting an upcoming reversal in the price of an asset. Trending markets are the easiest markets to make a profit in because the direction of the trend is predictable and we can place trades as long as the trend lasts.
- The SMI Ergodic works similarly to the True Strength Index (TSI) indicator, but with added benefits such as a signal line and double smoothening. The TSI indicator is one of the most accurate oscillator indicators, which means the SMI Ergodic is equally accurate.
- It is one of the few indicators that traders can use in isolation without worrying about accuracy because it’s complete – it utilizes the EMA to derive recent price data and smoothens it to increase the accuracy of the signals.
What Is The SMI Ergodic Indicator?
The Stochastic Momentum Index (SMI) Ergodic is a momentum oscillator that is based on the True Strength Index (TSI) plus a signal line. This is an indicator for experienced traders who need reliable data for trend trading by predicting an upcoming reversal in the price of an asset.
The SMI Ergodic name is a mouthful, but the indicator is among the top 10 most accurate indicators for trend trading and should be included in every trader’s arsenal. The TSI index is already accurate as a standalone indicator, but the SMI Ergodic takes it a level further by adding a signal line to enhance the accuracy of the buy & sell signals.
As the SMI Ergodic indicator is based on the TSI, the prices on the indicator are derived from the Exponential Moving Average (EMA). The EMA is an iconic indicator that sends signals based on whether the candles are moving below or above the EMA line. It places an emphasis on recent price data which makes it a “weighted” indicator.
The SMI Ergodic is considered a leading indicator due to the EMA weighing on recent prices.
What Is The SMI Ergodic Indicator Formula?
The SMI Ergodic indicator does not have a single formula. It uses three different formulas for the different lines in the indicator. The most important of these is the TSI formula which is used for the SMI indicator line:
The SMI line takes averages from the PCDS (Price Close Double Smoothed) and divides it by the APCDS (Absolute Close Double Smoothed), then multiplies it by 100 to get a result. These averages are based on the EMA. If the output is a positive number (i.e. Bitcoin grew over an x-period EMA), then we’ll likely get a positive number and the SMI line will trend up.
The histogram oscillator formula is “TSI – EMA * TSI”. The signal line formula is “EMA * TSI”. These are calculated over x-periods. As we have different outputs for each value, the SMI Ergodic indicator settings on Phemex are a 20-period for the long length (SMI) and two 5-periods for the short length (Signal and EMA).
The “Ergodic” part in the indicator name refers to a mathematical predictability scenario in which the average result of a group of people is the same as the average result of one individual. For example, if 100 people flip 100 coins, the outcome in terms of heads or tails will be similar to 1 person flipping 100 coins. In trading, this theory is used to calculate future prices based on historic prices.
How to Use the SMI Ergodic Indicator?
Here is a step-by-step guide on using the SMI Ergodic Indicator on the Phemex trading platform. First, select your trading pair (for this example, we will use BTC/USDT.) Click on “Indicators” at the top:
From the drop-down, type in and click “SMI Ergodic Indicator.” The indicator will start oscillating below the Bitcoin chart now:
If we use the “Settings” button we can adjust the EMA period length manually or change the colors of the lines:
For trend traders the default arrangement of 5:20:5 is excellent, but long-term value investors can extend these values to 50 or 100 if they want to take longer historical data to determine support levels before investing.
How to Read the SMI Ergodic Indicator?
The SMI Ergodic indicator can be confusing for beginner traders because there are two lines and a red histogram which shape-shifts. It appears below the price chart.
There are three important elements to the indicator:
- The signal line (TSI-based): Orange (oscillator). Location: Up and down.
- The SMI/TSI line (TSI-based): Blue (oscillator). Location: Up and down.
- The histogram (volume/EMA-based): Red (little bars). Location
The histogram, located in the middle, moves in triangle-like patterns above or below a zero line when there is a trending market. Movement above the zero line indicates bulls dominate the market; movement below the line indicates that bears dominate the market. If the extensions above the zero line are minor, this indicates a choppy market.
The crossover between the “SMI” and “Signal” lines indicates a new price trend and sends us buy and sell signals. If the SMI line is above the Signal line, it is a bullish trend. If the Signal line is above the SMI line, it is a bearish trend. Even if a trader doesn’t use the crossover strategy, they should check the histogram for safety.
BUY: Blue line above orange line. SELL: Orange line above blue line.
How to Trade With the SMI Ergodic Indicator?
The SMI Ergodic Indicator strategy is based on a crossover between the “Signal” and “SMI” lines. The red histogram in the middle only tells us the current trend – i.e. if it’s below the zero line, it’s bearish and if it’s above it’s bullish.
If we’re placing a long trade, the first thing we should check is if the histogram is above the zero line or we lose risking capital. Once we’ve confirmed the trend direction, we can implement a crossover trading strategy during which we wait for the blue line to cross the orange line and diverge.
The SMI Ergodic is surpassingly accurate for predicting future price directions:
Once the signal line crosses above the SMI/TSI line, this is a sell signal, and vice versa. The price has always shifted in that direction predictably, but the trends have not always persisted historically. A trader shouldn’t blindly follow the crossover and should expect the trend might not hold. For example, on the far right of the example above we can see the lines crossed but only for a brief amount of time.
The only way to confirm if a trend will last is to wait for the lines to cross and completely deviate from each other. We can also observe the histogram for the extension of the red lines which indicate a deep bull or bear market. If the red lines are smaller and not expanding in one direction, we’re in a choppy market and should avoid placing risky trades.
Traders also have the option of using only the histogram to place trades, without the crossover strategy. For example, if the histogram deviates by +0.1 or -0.1 on the 1D (daily) chart, we can expect a trend rise in that direction and open a trade accordingly; the trade can be closed once the trend starts dying down.
The same crossover trading techniques can be implemented on Ethereum (ETH) or any of the hundreds of altcoins. The idea to remember is to wait for the lines to cross before opening a trade, and always check if the histogram is aligned with the trade direction you’re aligning with:
The indicator predicted two perfect uptrends and downtrends in the price of Ethereum in the last two months. In the first example, Ethereum rose by nearly 40% and in the second it declined by an equal amount. The SMI Erdogic picked up on these signals as they unfolded and informed traders about the new trend pattern.
Conclusion
The SMI Ergodic indicator oscillator is among the most accurate of leading indicators. Understandably, it is less popular due to its complex name and the fact that it uses the TSI indicator formula. However, it can be a gamechanger for traders that need leading indicators for trend trading and want to have access to reliable TA tools.
The oscillator values we’re seeing are derived from the Exponential Moving Average (EMA) and double-smoothened to produce accurate data for traders. This indicator is unique because it can be used for crossover trading (buy/sell signals) and trend trading by buying during bear markets and selling during bull markets.
This indicator is one of the few indicators that trades can use in isolation without worrying about accuracy because it’s complete – it utilizes the EMA to derive recent price data and smoothens it to increase the accuracy of the signals.
To learn more about the indicators traders can combine with the SMI Ergodic, visit our technical analysis section.
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