How to use a moving average or an expontetial moving average

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How to use EMAs

Many of you have questions about how to use a moving average or an expontetial moving average or which setting are the right.For the first part of the question I have answers. For the second part of the question, as I have said in some comments there is nothing standard about it. You should make your backtest, you should make your paper trades and see which settings fit better to your strategy. I could tell you which settings fit to my strategies.

First of all I prefer EMAs because they are more focused on the present and I am a day trader. MAs are more focused on the past.So, how can you use the EMAs?

In this chart I have 2 EMAs. A green one with 4 periods and a red one with 8 periods. I use these settings only in 1min chart and mainly in 60 secs trades. Look at the blue rectangle.We have a crossover and now the green EMA is above the red. This is s buy signal.On the other hand we have a sell signal.

In this chart you can see that the big red candle in the rectangle breaks the 2 EMAs. If the next candle open below the two EMAs we have a sell signal.On the other hand we have a buy signal.(I mean if a bearish candle breaks up the 2 EMAs and the next candle open above the 2 EMAs.)

For bigger Tfs like 5 minutes I use 13, 26 EMAs.

Many times EMAs can act as a support or a resistance.This is an example of 200 EMA acting as a support in a 5min chart.

Personally, If I want to use EMAs to identify supports or resistances I use Tenkan and Kijun of the Ichimoku Kinko Hyo. Look at the next chart.

It’s from AUDUSD currency pair. The price breaks the Kumo and we have a clear down trend. The tenkan is the red line and the Kijun is the blue. Notice how well the Tenkan rejects the price when the price is trying to move up. It’s a solid physical resistance. I can count 4 or more ITM trades in this chart in the direction of the trend.

You can take some good trades with EMAs but of course is not a holly grail. Combine them with Volume, Price Action, Ichimoku Kinko Hyo and you will have all you need to trade.

Simple vs. Exponential Moving Averages: What’s the Difference?

Simple vs. Exponential Moving Averages: An Overview

Traders use moving averages (MA) to pinpoint trade areas, to identify trends, and to analyze markets. Moving averages help traders isolate the trend in a security or market, or the lack of one, and can also signal when a trend may be reversing. Two of the most common types are simple and exponential. We will look at the differences between these two moving averages, helping traders determine which one to use.

Moving averages reveal the average price of a tradable instrument over a given period of time. However, there are different ways to calculate averages, and this is why there are different types of moving averages. They are called “moving” because, as the price moves, new data is added into the calculation, therefore changing the average.

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Key Takeaways

  • Moving averages (MA) are the basis of chart and time series analysis.
  • Simple moving averages and the more complex exponential moving averages help visualize the trend by smoothing out price movements.
  • One type of MA isn’t necessarily better than another, but depending on how a trader uses moving averages, one may be better for that particular individual.

Simple Moving Average

To calculate a 10-day simple moving average (SMA), add the closing prices of the last 10 days and divide by 10. To calculate a 20-day moving average, add the closing prices over a 20-day period and divide by 20.

Given the following series of prices:
$10, $11, $11, $12, $14, $15, $17, $19, $20, $21
The SMA calculation would look like this:
$10+$11+$11+$12+$14+$15+$17+$19+$20+$21 = $150
10-day period SMA = $150/10 = $15

Old data is dropped in favor of new data. A 10-day average is recalculated by adding the new day and dropping the 10th day, and this process continues indefinitely.

The following chart shows a 100-day SMA applied to a chart of Macys, Inc. (M). It helps highlight the downtrend on the left and the rally on the right of the chart. At any given time, this SMA line is showing the average price of the most recent 100 trading sessions/candles.

Exponential Moving Average

The exponential moving average (EMA) focuses more on recent prices than on a long series of data points, as the simple moving average required.

To Calculate an EMA

Current EMA = ((Price(current) – previous EMA) X multiplier) + previous EMA.

The most important factor is the smoothing constant that = 2/(1+N) where N = the number of days.

A 10-day EMA = 2/(1+10) = 0.1818

For example, a 10-day EMA weights the most recent price at 18.18 percent, with each data point after that being worth less and less. The EMA works by weighting the difference between the current period’s price and the previous EMA and adding the result to the previous EMA. The shorter the period, the more weight applied to the most recent price.

Key Differences

SMA and EMA are calculated differently. The calculation makes the EMA quicker to react to price changes and the SMA react slower. That is the main difference between the two. One is not necessarily better than another.

Sometimes the EMA will react quickly, causing a trader to get out of a trade on a market hiccup, while the slower-moving SMA keeps the person in the trade, resulting in a bigger profit after the hiccup is finished. At other times, the opposite could happen. The faster moving EMA signals trouble quicker than the SMA, and so the EMA trader gets out of harm’s way quicker, saving that person time and money.

Each trader must decide which MA is better for his or her particular strategy. Many shorter-term traders use EMAs because they want to be alerted as soon as the price is moving the other way. Longer-term traders tend to rely on SMAs since these investors aren’t rushing to act and prefer to be less actively engaged in their trades.

Ultimately, it comes down to personal preference. Plot an EMA and SMA of the same length on a chart and see which one helps you make better trading decisions.

The following chart shows a 100-day SMA (blue) and EMA (pink) on a chart of Alphabet Inc. (GOOG). The EMA reacts quicker to price changes and tends to cling closer to the price action. The SMA is slower to react and has a tendency to stay further from the price, giving it more room.

As a general guideline, when the price is above a simple or exponential MA, then the trend is up, and when the price is below the MA, the trend is down. For this guideline to be of use, the moving average should have provided insights into trends and trend changes in the past. Pick a calculation period—such as 10, 20, 50, 100, or 200—that highlights the trend, but when the price moves through it tends to show a reversal. This applies whether using a simple or exponential MA. Test out various MAs to see which works best by altering the inputs on the indicator in your charting platform. Different MAs make work better on different types of financial instruments, including stocks.

Special Considerations

As lagging indicators, moving averages serve well as support and resistance lines. During an uptrend, the price will often pull back to the MA area and then bounce off it, as can be seen, a number of times on the chart above.

If prices break below the MA in an upward trend, the upward trend may be waning, or at least the market may be consolidating. If prices break above a moving average in a downtrend, the trend may be starting to move up or consolidating. In this case, a trader may watch for the price to move through the MA to signal an opportunity or danger.

Other traders aren’t as concerned about prices moving through the MA but will instead put two MAs of different lengths on their chart and then watch for the MAs to cross.

The chart below uses a 50- and 100-day SMA in the SPDR S&P 500 ETF (SPY). Sometimes, the MA crossovers provided very good signals that would have resulted in large profits, and other times, the crossovers resulted in poor signals. This highlights one of the weaknesses of moving averages. They work well when the price is making large trending moves but tend to do poorly when the price is moving sideways like it was on the left-hand side of the chart.

For longer-term periods, watch the 50- and 100-day, or 100- and 200-day moving averages for longer-term direction. For example, using the 100- and 200-day moving averages, if the 100-day moving average crosses below the 200-day average, it’s called the death cross. A significant down move is already underway. A 100-day moving average that crosses above a 200-day moving average is called the golden cross and indicates that the price has been rising and may continue to do so. Shorter-term traders may watch an 8- and 20-period MA, for example. The combinations are endless.

Exponential Moving Average – EMA Definition

What is Exponential Moving Average – EMA?

An exponential moving average (EMA) is a type of moving average (MA) that places a greater weight and significance on the most recent data points. The exponential moving average is also referred to as the exponentially weighted moving average. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average (SMA), which applies an equal weight to all observations in the period.

Key Takeaways

  • The EMA is a moving average that places a greater weight and significance on the most recent data points.
  • Like all moving averages, this technical indicator is used to produce buy and sell signals based on crossovers and divergences from the historical average.
  • Traders often use several different EMA days, for instance, 20-day, 30-day, 90-day, and 200-day moving averages.

The Formula For EMA Is

The three basic steps to calculating the EMA are:

  1. Calculate the SMA.
  2. Calculate the multiplier for smoothing/weighting factor for the previous EMA.
  3. Calculate the current EMA.

Calculating the EMA

To calculate an EMA, you must first compute the simple moving average (SMA) over a particular time period. The calculation for the SMA is straightforward: it is simply the sum of the stock’s closing prices for the number of time periods in question, divided by that same number of periods. So, for example, a 20-day SMA is just the sum of the closing prices for the past 20 trading days, divided by 20.

Next, you must calculate the multiplier for smoothing (weighting) the EMA, which typically follows the formula: [2 ÷ (selected time period + 1)]. So, for a 20-day moving average, the multiplier would be [2/(20+1)]= 0.0952.

Finally, to calculate the current EMA, the following formula is used: [Closing price-EMA (previous day)] x multiplier + EMA (previous day)

The EMA gives a higher weighting to recent prices, while the SMA assigns equal weighting to all values. The weighting given to the most recent price is greater for a shorter-period EMA than for a longer-period EMA. For example, an 18.18% multiplier is applied to the most recent price data for a 10-period EMA, whereas for a 20-period EMA, only a 9.52% multiplier weighting is used. There are also slight variations of the EMA arrived at by using the open, high, low or median price instead of using the closing price.

Simple Vs. Exponential Moving Averages

What Does The Exponential Moving Average Tell You?

The 12- and 26-day exponential moving averages (EMAs) are often the most popularly quoted or analyzed short-term averages. The 12- and 26-day are used to create indicators like the moving average convergence divergence (MACD) and the percentage price oscillator (PPO). In general, the 50- and 200-day EMAs are used as signals of long-term trends. When a stock prices crosses its 200-day moving average, it is a technical indicator that a reversal has occurred.

Traders who employ technical analysis find moving averages very useful and insightful when applied correctly but create havoc when used improperly or are misinterpreted. All the moving averages commonly used in technical analysis are, by their very nature, lagging indicators. Consequently, the conclusions drawn from applying a moving average to a particular market chart should be to confirm a market move or to indicate its strength. Very often, by the time a moving average indicator line has made a change to reflect a significant move in the market, the optimal point of market entry has already passed. An EMA does serve to alleviate this dilemma to some extent. Because the EMA calculation places more weight on the latest data, it “hugs” the price action a bit more tightly and therefore reacts more quickly. This is desirable when an EMA is used to derive a trading entry signal.

Interpreting the EMA

Like all moving average indicators, they are much better suited for trending markets. When the market is in a strong and sustained uptrend, the EMA indicator line will also show an uptrend and vice-versa for a down trend. A vigilant trader will not only pay attention to the direction of the EMA line but also the relation of the rate of change from one bar to the next. For example, as the price action of a strong uptrend begins to flatten and reverse, the EMA’s rate of change from one bar to the next will begin to diminish until such time that the indicator line flattens and the rate of change is zero.

Because of the lagging effect by this point, or even a few bars before, the price action should have already reversed. It follows, therefore, that observing a consistent diminishing in the rate of change of the EMA could itself be used as an indicator that could further counter the dilemma caused by the lagging effect of moving averages.

Common Uses of the EMA

EMAs are commonly used in conjunction with other indicators to confirm significant market moves and to gauge their validity. For traders who trade intraday and fast-moving markets, the EMA is more applicable. Quite often, traders use EMAs to determine a trading bias. For example, if an EMA on a daily chart shows a strong upward trend, an intraday trader’s strategy may be to trade only from the long side on an intraday chart.

The Difference Between EMA and SMA

The major difference between an exponential moving average and a simple moving average is the sensitivity each one shows to changes in the data used in its calculation.

More specifically, the EMA gives a higher weighting to recent prices, while the SMA assigns equal weighting to all values. The two averages are similar because they are interpreted in the same manner and are both commonly used by technical traders to smooth out price fluctuations. Since EMAs place a higher weighting on recent data than on older data, they are more reactive to the latest price changes than SMAs are, which makes the results from EMAs more timely and explains why the EMA is the preferred average among many traders.

Limitations Of The EMA

It is unclear whether or not more emphasis should be placed on the most recent days in the time period or on more distant data. Many traders believe that new data will better reflect the current trend the security is moving with; meanwhile others feel that privileging certain dates than others will biases the trend. Therefore, the EMA is subject to recency bias.

Similarly, the EMA relies wholly on historical data. Many people (including economists) believe that markets are efficient – that is, that current market prices already reflect all available information. If markets are indeed efficient, using historical data should tell us nothing about the future direction of asset prices.

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