what is ema in trading

What is EMA in Trading: An Essential Guide to Moving Average

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The EMA indicator is an effective modified tool. It considers the values of simple/weighted moving average parameters. It is an ordinary Moving Average with the Exponential method in the settings. Exponential is usually considered the most convenient and successful option.

EMA indicator takes a set of data (closing price levels for a specified period) and submits their average price. Moreover, the MA moves together with the price.  Any ranges and boundaries do not limit it. Timeframes can be different. Moving averages on all timeframes can lag. As a rule, the larger the period, the stronger the lag is (on small timeframes, the lag is minimal). EMA trading is often used with other indicators. Even the strongest signals generated may not be accurate enough to open a trade.

How do the traders use the indicator:

  1. In trading strategies. They combine them with other indicators, wave or Japanese candlestick analysis, etc.
  2. To determine the current trend.
  3. To find the places for setting Stop-Loss.
  4. To receive trading signals after crossing moving average lines.
  5. As support/resistance zones.

This article will look closer at the moving averages indicator. So we help to “sift through” market noise.

An exponential moving average is a technical analysis tool. It tracks the price of an investment over time. It is important to understand the meaning of EMA in trading. The EMA is more sensitive to price changes. You can calculate it similarly to the SMA. But you focus on the closest data periods, not those in the “tail” of the period. EMAs are useful for estimating the curve’s front due to their priority to fresh data.

All moving averages have their arguments.  You can customize them individually depending on:

  • your trading strategy;
  • timeframe;
  • instruments, and other conditions. 

Having equal adjustment periods, each moving average will behave uniquely. Also, to determine the general trend, traders use the MA indicator. They calculate possible support and resistance levels. Moving average crossovers can also signal trend strength or continuation.

For example, a price below the 200-day moving average can signal a strong bearish trend. The example with the price below the 50-day moving average is a short-term downtrend. This is a strong bullish trend when it happens simultaneously:

  • the price of an asset is above the 200-day moving average;
  • above the 50-day moving average.

Integration of EMA with Other Technical Indicators

Traders use the EMA as a stock indicator to identify the trend. When it is in a price breakout strategy. One example is a trend-following strategy. It uses the EMA indicator and Bollinger Bands to generate trading signals.

The Bollinger Bands form an “envelope” of volatility above and below the price on the chart. If the price moves outside of the envelope, it can be a signal to trade in that direction. This only happens if our trend filter, represented by:

  • the short-term EMA line;
  • the long-term EMA line, confirms the direction. 

Thus here you can see what EMA is in trading

  • A buy signal will be a price breakout of the upper Bollinger Band with the short-term EMA above the long-term EMA;
  • A sell signal will be a breakout of the lower Bollinger Band with the short-term EMA below the long-term EMA.

EMA as a Filter for Entry and Exit Signals

EMA (Exponential Moving Average) acts as a filter for entry and exit signals in trading. It helps traders identify the direction of the prevailing trend. For entry signals, traders may look for price crossovers above the EMA during:

  • uptrends;
  • below it during downtrends. 

As for exit signals, price crossing below the EMA can be potential exit points in the case of:

  • uptrend;
  • above the EMA in a downtrend.

EMA trading aids in smoothing price movements, reducing noise, and enhancing trading decisions.

Understanding EMA Calculation

understanding ema calculation

It is a continuously calculated arithmetic average of prices over a certain period. “Moving” because we calculate new values at each successive time interval.  And the average value is actually adjusted as prices change.  

You can calculate a moving straight line for any time-varying data. But it is most often used concerning asset prices in technical analysis. 

For example, a 30-day moving average can be helpful. Its value is the arithmetic average of the price over the previous 30 days. In other words, we add the closing prices for all those 30 days and then divide by 30. If you know how to calculate EMA, you can do it every day. You replace the dataset’s oldest value with the last day’s value.

Economists and analysts have been using moving averages in their research. But these days, calculating moving averages on almost any time frame is just a click away. Read further to discover this in more detail. 

Smoothing Factor and Its Role

The smoothing factor is also known as the “weight” or “multiplier.” It plays a crucial role in calculating the EMA. It determines the rate at which older data is exponentially decayed. So it gives more weight to recent data points. A smaller smoothing factor results in a faster-reacting EMA. While a larger factor leads to a smoother EMA stock indicator that reacts more slowly to price changes. This makes EMA more responsive to recent price movements. And it reduces lag compared to other moving averages.

Step-by-Step Calculation Process

To calculate the EMA step-by-step, follow these steps:

  1. Choose a period.
  2. Calculate the Simple Moving Average (SMA) for the first period.
  3. Determine the smoothing factor.
  4. For subsequent periods, apply the EMA formula.
  5. Repeat for each day, using the latest EMA for the next calculation.

Interpreting EMA Signals

ema signals

Trading with the help of any moving averages can sometimes be difficult. After all, all the representatives of the trader’s headache appear at once:

  • the ambiguity of signals;
  • inability to adjust to changing volatility;
  • confusion with the choice of indicator period, etc. 

But if a trader, through all this pain, comes to a sane strategy based on the meaning of EMA trading – he will be able to trade at any time and in any market. Read below for more about Interpreting EMA Signals. 

Bullish and Bearish Crossovers

Traders often use the EMA crossover when creating new signals. The short-term exponential moving average crosses the long-term moving average upwards. This is usually considered bullish, while the opposite is bearish. These crossovers are sometimes called the “Golden Cross” and “Death Cross” respectively.

Support and Resistance

Support and resistance are integral to any financial market. Market participants determine these levels, which are essentially supply and demand levels. Support and resistance levels have value in EMA trading. This happens when the market sticks to these levels most of the time. If the S&R level is only used occasionally or rarely, then a trader cannot use it to place it on a chart. Traders are looking for how to find S&R levels to build a trading strategy.

Upward and Downward Slopes

The slope of an EMA line can provide valuable information about the strength and momentum of a trend. When the EMA has a steep upward slope, it suggests a strong and accelerating uptrend. It indicates that the asset’s price is rising rapidly. An abrupt downward slope of the EMA stock indicator suggests a strong and accelerating downtrend. It signalizes that the asset’s price is declining rapidly.

Traders often consider assets whose EMAs show significant slopes. After all, these are potential opportunities for profitable trades. But, it is essential to combine this analysis with other technical indicators to:

  • confirm the strength of the trend;
  • prevent false signals.

Multiple Analysis

It is important to build several EMAs with different periods on the price chart. It allows traders to understand the trend of asset development better. For example, plotting a 20-period, 50-period, and 200-period EMA on the chart allows you to know:

  • short-term;
  • medium-term;
  • long-term trends, respectively.

False Signals of Ema

A false breakout in trading occurs when the price moves through some level. But it does not have enough momentum and thus moves back behind the level.

The level can be:

  • horizontal support or resistance level;
  • the boundary of a chart pattern formation;
  • round psychological levels;
  • trend lines / Fibonacci levels/channels, and other elements.

The EMA stock indicator shows false breakouts. Especially when the market does not offer a clear direction. In a sideways movement, false EMA signals appear frequently. Then the EMA is actually broken by the price from the bottom up and from the top down. In such cases, the stop loss takes place far behind the opposite polarity of the EMA. It targets nearby local extrema. The above definition is rather vague. But the false breakouts are well understood even by traders with little experience. Read further to master this topic.

Availability of Whipsaws

Whipsaw in trading describes a sharp increase or decrease in an asset’s price. It goes against the prevailing trend. Whipsaw is different from other reversals. Because it is usually characterized by a sudden change in an asset’s momentum. It happens shortly after a trader has opened their position. Traders may interpret these crossovers as EMA entry or exit signals in trading. But the price may reverse quickly, resulting in false signals and potential losses.

Spike During News Events

Significant news events or sudden market shocks can cause sharp price spikes. It can lead to temporary EMA crossovers. But, these crossovers may not reflect a sustained trend change. They could be deceptive, causing traders to enter or exit positions prematurely.

Market Gaps

During market gaps, the EMA line may show a sudden gap, creating false signals. Traders might interpret this as an important trend change. But it could merely result from the market’s discontinuity. So it is not an accurate representation of price movement.

How to Calculate EMA

The formula for calculating the value of the EMA at period t can be as follows:

ema formula
  • α is the weight coefficient in the interval from 0 to 1. It reflects the aging rate of the past data. The higher its value:

– the greater the specific weight of new observations of the random variable is.

– and the smaller the old ones are;

  • Pt is the value of the random variable in the time t;
  • EMAt-1 is the value of the exponential moving average in the period (t-1).

There is no mathematical formula for calculating the optimal value of the α coefficient. And it is usually found by the selection method. In this case, the selection criterion is the minimization of the standard deviation error of the actual value of a random variable from the forecast one. In practice, it looks as follows:

  1. A trader selects several values of the α coefficient.
  2. A trader calculates the RMS error for each value of the α.
  3. The optimal value of α is the value at which the RMS error is minimal.

But, this approach with EMA trading does not apply to technical analysis of the real market. Because the statistical series is constantly supplemented with new price values. This makes it impossible to:

  • fix the α coefficient;
  • meet the criterion of minimizing the RMS error simultaneously. 

For this purpose, the following formula is useful to calculate the α coefficient:

formula to calculate the a coefficient

where N is the smoothing interval.

It is necessary to know what EMA in trading is to find its value in the previous period (t-1). You need it to calculate the exponential moving average value in period t. In this case, the SMA with the same smoothing interval is usually taken as the first value.

Speaking about EMA of arbitrary order, as a rule, we distinguish two special cases of this type of EMA:

  • exponentially double the exponential moving average;
  • triple exponential moving average. 

The order determines the degree of price smoothing. So the higher the order, the stronger the smoothing is. The EMAt value is often smoothed in this case rather than the initial price pt. In this case, the formula will look as follows:

full formula of ema

Bottom Line

We have looked at how price data can be smoothed if you know what is EMA in trading. This indicator not only helps to confirm a trend but can also be used to generate trading signals. 

You can test different exponential moving average settings on a free demo account.  Do it to determine which best suits your trading style. The demo account allows you to practice trading using virtual currency, i.e., without risking your funds. Start practicing today to find the perfect one for you!

FAQs

EMA shows the average price value for the period selected by the trader. In this case, the calculation is carried out so that newer price values have more weight than older ones.

For day trading, traders often use short-term EMAs, such as 9, 12, or 20 periods, to capture intraday price movements and react quickly to market changes.

EMA stands for “Exponential Moving Average” in trading, a popular technical indicator used to analyze price trends and generate trading signals based on recent price data.

A simple moving average (SMA) calculates the average of a set of historical data for a certain period, where all data have the same weight. Unlike the SMA, the exponential moving average (EMA) assigns different weights to price values.

EMA is calculated at time t using the exponential moving average formula as follows: EMAt = α x current price + (1- α) x EMAt-1, where α is a smoothing constant with a value between 0 and 1, and EMAt-1 is the EMA for the previous period.

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