Moving averages are technical indicators that are used by market analysts and investors to determine the direction of a trend. They sum up the data points of a financial asset over a specific time and divide the total by the number of data points to arrive at an average.
In this article, we are going to focus on the most popular version of moving averages, the Exponential Moving Average (EMA).
Just like the ordinary moving average, the exponential moving average is a technical indicator but it differs from other moving averages in that its calculations give more weight to the most recent price data. In the process, the EMA provides important insights on the most recent market behavioral traits as a tool for most traders. In tracking the most recent movements the exponential moving average indicator reacts quickly to changes in the price of an asset.
When it comes to setting up your exponential moving average strategy, the most common parameters used by most traders in setting an EMA time frame are 50, 100 and 200 day periods for the long-term line. In picture #1 I’m using the daily timeframe as an example, but the same applies to all time frames so that e.g. the 200 EMA on the 1H chart will be calculated based on the last 200 hourly candles. The default short-term time frames used by most traders are the 12-day and 26-day EMAs, but I mostly use the 21-day EMA. However, it is important to modify the EMA parameters when you trade new coins because there is no one-size-fits-all setup when it comes to an EMA indicator.
Picture #1 — Long term EMAs
Picture #2 — Short term EMAs
Picture #3 — Finding EMA indicator on TradingView
Picture #4 — Finding EMA indicator on TradingView
Picture #5 — Set up EMA indicator on your wished time frame
The EMA is basically a more advanced version of the SMA, which is simply the sum of the closing prices during a period, divided by the number of records for that period. For example, a 30-day SMA is just the sum of the closing prices for the past 30 trading days, divided by 30.
To calculate the EMA you must calculate the multiplier for smoothing (weighting) the EMA, which typically follows this formula: [2 divided by (the number of observations plus 1)]. For a 30-day moving average, the multiplier would be [2/(30+1)]= 0.0645.
To calculate the current EMA we use the following formula:
Closing price x multiplier + EMA (previous day) x (1-multiplier) = EMA
The exponential moving average gives priority to recent prices, while the simple moving average distributes equal weight 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, a 9.52% multiplier is applied to the most recent price data for a 20-period EMA, while the weight is only 6.45% for a 30-period EMA.
The most quoted and analyzed exponential moving averages (EMAs) for short-term averages are the 12- and 26-day indicators. These 12 and 26 days EMAs are also used to create other indicators like the Moving Average Convergence Divergence (MACD) and the Percentage Price Oscillator (PPO). As a general rule of thumb, the 50- and 200-day EMAs are used as indicators for long-term trends. When a price crosses the 200-day EMA, traders can interpret this as a technical signal that a reversal has occurred (it means that EMA 200 is now acting as a support and not as resistance anymore).
Picture #6 — EMA200 chart interpretation
Most traders who rely on technical analysis find EMAs very useful and insightful when applied correctly. However, it is also important to note that these signals can lead one astray when used improperly or misinterpreted. This is mainly because all the moving averages commonly used in technical analysis are, by their very nature, lagging indicators that follow behind the market.
The insights interpreted from applying a moving average to a particular market chart should be to confirm a market move or to tell its strength. The optimal time to enter the market often passes before a moving average shows that the trend has changed. The EMA indicator does serve to help expel some of the negative effects of such time lags to some extent as the EMA calculation prioritizes the latest data, tracks the price action a bit more closely and reacts faster.
One of the major characteristics of all moving average indicators is that they are all better suited for trending markets and the EMA is not spared from all this. When the market is in a positive and prolonged uptrend, the EMA indicator line will also show an uptrend and vice-versa for a downtrend. An alert trader will pay attention to both the direction of the EMA trendline and the relation of the rate of change from one bar to the next. For example, if the price action of a strong uptrend begins to weaken and reverse, it might be time to get out of the trade.
Day traders who prefer to execute their trades swiftly, the EMA is often the preferred moving average indicator. When coming up with your trading strategy you can use the EMA as the only standalone indicator for your trading strategy, but you have to make sure you have a clear set trading plan with which to confirm the signals identified using EMA. You can also set up two EMAs with different time frames, or combine them with other technical analysis indicators.
In practice, a buy- or golden-cross trading signal occurs when EMA50 moves above EMA200, known as a golden-cross signal. A sell signal (known as a death cross) can be identified when the EMA50 line moves below the EMA200 line.
Picture #7 — Golden and Death cross
Before defining and plotting an exponential moving average for the selected coin, you should make sure that you know how to read and interpret EMA. The application of EMA when executing trades follows the general rules for moving average indicators, which can be interpreted in short as:
An EMA with a longer time frame helps you identify the general trend of the market and If the price crosses a long-term EMA, such as the 200-day line, this indicates a potential reversal (as shown before).
To identify crossovers/reversals a trader should consider plotting one EMA with a short time frame and another with a longer time frame.