Trading Knowledge — How To Use Exponential Moving Average (EMA)

Trading Knowledge — How To Use Exponential Moving Average (EMA)

Many investors and active traders use technical trading indicators to help identify high-probability trade entry and exit points. Hundreds of indicators are available on most trading platforms. Therefore, it is easy to use too many indicators or to use them inefficiently. This article will explain how to use EMA indicators to take advantage of these technical analysis tools.

What is an Exponential Moving Average (EMA)?

An Exponential Moving Average (EMA) is used to identify the predominant trend in the market. It can also provide the support and resistance levels you need to execute your trade. An Exponential Moving Average is very similar to (and is a type of) a weighted moving average. The major difference between an EMA and an SMA is the sensitivity each one shows to changes in the data used in its calculation. More specifically, the EMA gives higher weights to recent prices, while the SMA assigns equal weights 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 responsive to the latest price changes than SMAs. That makes the results from EMAs more timely and explains why many traders prefer them.

How To Use Exponential Moving Average (EMA)

Like all moving average indicators, EMAs are better suited for trending markets. When the market is in a solid and sustained uptrend, the EMA indicator line will also show an uptrend and vice-versa for a downtrend. A vigilant trader will pay attention to both the direction of the EMA line and the relationship between the rate of change from one bar to the next. For example, suppose the price action of a strong uptrend begins to flatten and reverse.

The mathematical formula for calculating EMA builds upon its previous values. Therefore, all price data remains up-to-date so that the newest data has a greater impact than the older price data.

EMA = Y + [K × (X − Y)]

Where:

X = Current price

Y = Previous period’s EMA (SMA is used for the first period’s calculations.)

K = Exponential smoothing constant (this gives the appropriate weight to the most recent prices, utilizing the specified period in the MA)

The EMA clarifies price action for traders by reducing the lag in the price chart. As a result, it smooths the price and makes the trend more reliable and accurate than with the traditional moving average. However, its greater price sensitivity may at times confuse traders. Therefore, the ideal approach is to use other technical indicators and EMA to determine the most accurate buying point.

EMA works like other moving average indicators, where the primary aim is to identify the market trend. If a crypto asset is in an uptrend, the price will be above the EMA. For a bearish trend, the price should remain below the EMA. On the other hand, a contraindication of the EMA would represent a correction in a trend, as shown in the image below:

The above image shows the three phases of a trend, which we can easily find using the EMA:

• Price is stable above the EMA: uptrend

• The price is stable below the EMA: downtrend.

• The price becomes unstable at the EMA: correction.

Investors should find a stable price above the EMA in cryptocurrency trading to open a buy position. In addition, a trend trader should understand how to gauge the strength of a trend.

Based on the EMA value, we can define a market trend as follows:

1. EMA 12 to 26 days: suitable for finding short-term trends

2. EMA 50 to 200 days: suitable for finding medium- and long-term trends

Long-term traders and HODLers should use an EMA of 50–200 days to identify the long-term price direction in cryptocurrency trading. On the other hand, the short-term trend is suitable for opening trades. However, the period of the EMA depends on the trader’s choice and flexibility. Fortunately, this can be easily adjusted to fit your trading plan.

There are many ways to trade cryptocurrencies using EMA. However, professional traders like to keep the system simple, using it for profitability.

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