Exponential Moving Average (EMA) & How I Use It

orionstafa
May 29, 2022
4 min read

What Is an Exponential Moving Average (EMA) and How Does It Work?

An exponential moving average (EMA) is a sort of moving average (MA) that gives the most recent data points more weight and relevance. The exponentially weighted moving average is another name for the exponential moving average. An exponentially weighted moving average reacts more strongly to recent price movements than a simple moving average (SMA), which gives all of the observations in the period identical weight.

Calculating the EMA

The EMA requires one more observation than the SMA to calculate. Assume you wish to use 20 days for the EMA's number of observations. Then you'll have to wait until the 20th day to get your SMA. The prior day's SMA can therefore be used as the first EMA for yesterday on the 21st day.

The SMA is a simple formula to calculate. It's just the total of the stock's closing prices for a given time period divided by the number of observations for that time period. A 20-day SMA, for example, is just the total of the closing prices for the previous 20 trading days divided by 20.

The multiplier for smoothing (weighting) the EMA is commonly calculated using the formula: [2 (number of observations + 1)]. The multiplier for a 20-day moving average is [2/(20+1)]=0.0952.

Finally, the current EMA is calculated using the formula below:

EMA = Closing price multiplied by the multiplier + EMA (prior day) multiplied by the multiplier (1-multiplier)

The EMA gives current prices more weight, whereas the SMA gives all values equal weight. For a shorter-period EMA, the weighting given to the most recent price is greater than for a longer-period EMA. For a 10-period EMA, for example, an 18.18 percent multiplier is applied to the most recent price data, whereas the weight for a 20-period EMA is only 9.52 percent.

There are also minor differences in the EMA calculated using the open, high, low, or median price rather than the closing price.

What Does the EMA Tell You?

Short-term averages such as the 12- and 26-day exponential moving averages (EMAs) are frequently mentioned and studied. Indicators like the moving average convergence divergence (MACD) and the percentage price oscillator are created using the 12- and 26-day (PPO). The 50- and 200-day EMAs are commonly utilized as long-term trend indicators. A technical signal that a reversal has occurred is when a stock price crosses its 200-day moving average.

When used correctly, traders who use technical analysis find moving averages to be incredibly useful and informative. They are also aware that when these signals are misused or misconstrued, they can cause disaster. Lagging indicators include all moving averages typically utilized in technical analysis.

As a result, the conclusions made from applying a moving average to a specific market chart should be to corroborate or signal the strength of a market move. Before a moving average signals that the trend has altered, the best time to enter the market has typically passed.

To some extent, an EMA helps to mitigate the detrimental effects of delays. The EMA computation "hugs" the price action a little tighter and reacts faster since it gives more weight to the most recent data. When an EMA is utilized to generate a trading entry signal, this is good.

EMAs, like all other moving average indicators, work best in trending markets. The EMA indicator line will show an uptrend when the market is in a strong and persistent upswing, and vice versa when the market is in a downtrend. A cautious trader will pay attention to the EMA line's direction as well as the pace of change from one bar to the next. Consider what happens when a strong uptrend's price motion flattens and reverses. From the standpoint of opportunity cost, it may be time to switch to a more bullish investment.

Examples of How to Use the EMA

EMAs are frequently used in conjunction with other indicators to confirm and assess important market moves. The EMA is better appropriate for traders who trade intraday and fast-moving markets. EMAs are frequently used by traders to determine a trading bias. An intraday trader's strategy may be to trade only on the long side if an EMA on a daily chart reveals a strong rising trend.

The Difference Between EMA and SMA

The main distinction between an EMA and a SMA is their sensitivity to changes in the data used to calculate them.

More specifically, the EMA gives recent prices more weight, whereas the SMA gives all values equal weight. The two averages are similar in that they are both employed by technical traders to smooth out price volatility and are viewed in the same way.

EMAs are more responsive to recent price movements than SMAs because they place a higher emphasis on recent data than older data. This makes the findings of EMAs more timely, which is why many traders favor them. 1

Limitations of the EMA

It's debatable whether the most recent days of the time period should be given more weight. Many traders feel that new data more accurately reflects the security's current trend. Others, on the other hand, believe that emphasizing current dates causes a bias that leads to more false alarms.

Likewise, the EMA is entirely based on historical data. Many economists believe that markets are efficient, meaning that current market prices already represent all relevant data. If markets are efficient, historical data should tell us nothing about asset price trends in the future.

What Is a Good Exponential Moving Average?

Long-term investors prefer the longer-day EMAs (50 and 200 days), whilst short-term investors prefer the 8- and 20-day EMAs. Here is an example of how i using the crossing EMA strategy, usually through out the day if you use smaller time frames you will see the EMAs crossing a lot except at one particular time. When the EMA crosses and you get a huge candle it is much more likely that the trend will continue on that direction. The #AAPL chart below it is a 15 minute last weeks chart 5-27-22

Is Exponential Moving Average Better Than Simple Moving Average?

The EMA is more focused on recent price movements, which means it reacts to price changes faster than the SMA.

How Do You Read Exponential Moving Averages?

A rising EMA is seen as a support for price activity, while a falling EMA is seen as a barrier. Investors should buy when the price is near the rising EMA and sell when the price is near the dropping EMA, according to this interpretation.