An exponential moving average (EMA) is a variant of the simple moving average (SMA) that places a higher weighting on the most recent data points when calculating the asset’s average price over a specified time period. Being more reactive to the most recent prices would make the EMA more sensitive to near-term price swings as opposed to the SMA, which gives the same weightage to data points in all periods, which makes it less reactive to smaller price changes since the calculation is spread evenly throughout the specified time period. Thus, the EMA is also referred to as the exponentially weighted moving average and is widely deemed to be more accurate in providing signals to traders in fast-moving and volatile markets like cryptocurrencies as compared with the SMA.
What Does The EMA Tell You?
The exponential moving average can give us insights to a lot of information pertaining to the asset in question. First of all, a moving average is generally good for telling whether an asset is cheap or expensive relative to its mean price over a specified period. For instance, if the price of a security like the paypal stock trades at $70 but its 50-day EMA is $100, we can gauge that the price of paypal is cheap relative to its 50-day average. Since markets have a tendency to revert to mean, this could be interpreted as bullish for the price of paypal for the long-term. In other words, moving averages are good at identifying when assets are overbought or oversold, and the exponential moving average is one such indicator.
Secondly, the exponential moving average can help a trader predict to a high level of accuracy, the likelihood of trend continuations. Generally, when in an uptrend, if an asset is able to maintain its price above the EMA, it is a sign that its bullish trend could continue. This feature of the EMA can be used in conjunction with other technical indicators like the RSI, candlesticks or chart patterns like the flag to help traders execute trend-following trades. As the saying goes, the trend is your friend. On the contrary, if an asset’s price falls below its EMA, it is often a sign that a trend reversal could be forthcoming.
In the same regard, when an asset’s price is trading at the same level as the EMA, it often implies that there is no volatility in the market and its price could remain range bound.
In addition to using the exponential moving average, we can confirm the absence of volatility using other indicators like the Bollinger Bands and the Average True Range (ATR). However, these will be subjects for another time, as our guide today is about the EMA.
How Does The Exponential Moving Average (EMA) Work?
The exponential moving average is used to produce buy and sell signals based on crossovers and divergences from an asset’s historical average over the user’s specified time period. What timeframe an investor uses depends on his investment holding period.
Typically, a long-term investor will use longer timeframes like 100-day and 200-day EMAs, while a short-term swing trader may prefer shorter time frames like the 12-day and 26-day EMAs. The 12-day and 26-day are respected by traders as they are used to create other variations of moving average indicators like the moving average convergence divergence (MACD) and the percentage price oscillator (PPO). Intraday traders often use even shorter timeframe EMAs like the 8-day and 20-day EMA. Which timeframe to use really depends on what the individual trader thinks works best for him, there is no right or wrong answer and a trader will usually have his own favourite after some trial and error.
How to Calculate The EMA
To obtain the exponential moving average of an asset, we first need to calculate its simple moving average to set it as the initial EMA value.
To find the simple moving average, we must first get the average figure of the required data points, which is in most cases, the past daily closing prices of our required time period. To illustrate, if you wish to find an asset’s 100-day SMA, then you will need to add the closing prices of the past 100 days, and then divide the sum by 100.
Next, calculate the weighting multiplier, or otherwise known as the smoothing constant. This is derived by dividing 2 by the number of periods, and then adding 1.
Lastly, deduce the EMA for each day between the initial EMA value and the current day using its price, the weighting multiplier as calculated above and the EMA value of the previous time period.
Formula For Exponential Moving Average (EMA)
To help you get a better picture, we have condensed the above exponential moving average description into the following formula which has a 3-step process:
SMA = (N – period sum) ÷ N
The weighting multiplier (or smoothing constant) = 2 ÷ (time period + 1)
EMA Calculation = (closing price – previous day’s EMA) x weighting multiplier + previous day’s EMA
When N equals the number of days in the required time period, and period sum is the summation of closing prices in that time period.
Example of How to Use The EMA
Traders typically use exponential moving averages to determine a trading bias. When an EMA on a chart shows a strong bullish trend, an intraday trader’s strategy may be to trade only on the long side whenever price moves near to the EMA level. The reverse is also true in that when an asset’s price trades consistently below its EMA, it is often a bearish sign.
To give you an example, consider the BTC 4-hour chart below.
As BTC has just broken a horizontal support on 12 June 2022 and price has consistently traded below its EMA, it is a good signal to short as the trend is clearly bearish. The area where the price reverts to trade near to the EMA is an especially good level to open a short. After the price has fallen and BTC starts to trade above the EMA regularly as seen in the chart above, it will be a good time to take profit.
What is the Difference Between Simple and Exponential Moving Averages?
The chief difference between an EMA and an SMA is the sensitivity to recent price changes.
As the exponential moving average gives higher weightage to more recent prices, it is more responsive to the latest price fluctuations of an asset and is deemed less laggy when compared with the SMA which often gives a smoother and flatter curve and thus, a lot less able to give pinpoint signals as to when to buy or sell, especially for short-term traders.
In particular, intraday traders use the EMA much more than the SMA since the EMA is able to react much quicker to even small price movements as compared with the SMA, which often gives a laggard signal on the trading chart when depicting short-term price action.
EMA Vs SMA
As a general guide, the EMA is better for predicting short-term price movements due to its sensitivity, while the SMA is better for estimating potential movement of an asset’s price for the long-term. For investors with a long-term perspective like 5-years or 10-years, the EMA may be deemed as “too noisy” with too many nooks and creases which is distracting for them, or worse, distorts the long-term price trajectory of the asset. Hence, each type of moving average has its merits and shortcomings.
How to Trade Crypto Using EMA at Margex?
The Margex platform offers the necessary technical tools to help anyone effectively trade with the EMA. However, this is not financial advice, and a trader should consider his own financial situation before trading any financial instrument. When in doubt, please seek advice from your independent financial advisor. Trading in leveraged financial instruments may come with a high risk of losing money and traders are advised not to trade more than what they can comfortably afford to lose.
After going through our disclaimer, let's follow our step-by-step guide below on how to trade crypto using the EMA on Margex.
Step 1: Open a trading account at Margex by going to its website at https://margex.com/
Click the top right-hand corner to register for an account. After your account has been successfully opened, which takes only about 30 seconds, you may log in to your account to start trading!
Step 2: Fund your account by clicking on the “Deposit” button (yellow box) as shown under the “Wallet” tab located on the top navigation bar. You may deposit in a variety of ways like Visa, Mastercard, or even in Bitcoin!
Step 3: On the Margex trading screen, you may freely access the technical tools available to analyse any crypto trading pair you like. Click on the “Trade” tab on the top navigation bar and you will be able to see and use Margex’s suite of technical charting tools.
Step 4: After identifying the pair you want to trade, click on the “Indicator” selector that is highlighted in the yellow rectangle where a pop-out window will appear. On the search function in the pop-up, key in “EMA”, where different types of EMAs will appear. Select “Moving Average Exponential” and close the window. You will find that the EMA indicator has been added to your trading chart.
To customize each EMA, go to the EMA Settings as circled in the top yellow circle on the below diagram and a pop-out window will appear. You can change the duration of the EMA under the “Length” tab as seen in the diagram below. For this example, we have used the duration 8.
You can add and remove many different EMAs with varying durations to your chart to customize your favourite signals.
Step 5: Identify the level you wish to do your EMA trade.
Final Step: Simply key in your desired order size and the price you want to trade at in the order ticket panel on the left of the screen and submit your ticket.
Using the ADA daily chart example above, as the price broke above a small resistance level with a bullish engulfing pattern on 10 August 2021 and price has been trading above the EMA, it is a good signal to enter a long trade. One can take profit after the price subsequently crosses back below the EMA as in the chart above.
Now that we have given you an in depth look at the exponential moving average and the ways it can help in your trading, let us do a quick run through on what we have learnt.
What is An EMA in Trading?
An exponential moving average (EMA) is a type of moving average indicator that places a high weightage on an asset’s most recent prices when plotting a curve representative of its mean price over the user’s specified time period. Having this mean price curve helps a trader estimate if an asset is overpriced or under-priced to help him with his trading decisions.
Is EMA Good For Trading?
Yes, the exponential moving average is definitely a good tool to use for trading, especially if you are a short-term trader focused on doing intraday or scalping trades.
Which EMA is Best For Trading?
For short-term swing traders, the 12-day in conjunction with 26-day EMA is best to identify trading opportunities as it is also used to construct the MACD, which is one of the most preferred trading indicators used by seasoned traders.
How is EMA Used in Stock Trading?
Similar to its use in cryptocurrency trading, the exponential moving average is most commonly used to identify trend continuation in stock trading. That said, the exponential moving average can also be useful for gauging whether a stock is overpriced or cheap by referencing its mean price over a longer-time period.
Which is Better, EMA or SMA?
The EMA and SMA each have their own advantages and disadvantages. Hence, instead of generalising which one is better, we may benefit more by knowing each of their characteristics and limitations and apply each to their specific use. For instance, the EMA is better for short-duration trading, while the SMA is better for gauging an asset’s long-term price trend.