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What is the Exponential Moving Average (EMA) indicator?
Exponential moving average (EMA), also known as exponentially weighted moving average (EWMA), is one of the oldest forms of technical analysis. It is a kind of moving average (MA) that assigns different weights and importance depending on how old or new a data point is. EMA is primarily used to identify dominant trends in the market and determine the level of support and resistance to execute trades. To understand the concept of an exponential moving average, let's first review what a moving average (MA) is.
Moving averages (Moving averages) represent the average price of a financial asset over a specified period of time, and different types of Moving averages usually differ in the way data points are weighted or given importance.
In fact, if you look at a chart with a simple moving average and an exponential moving average, you may not be able to distinguish the two at a glance. However, the two have several key differences in nature.
An exponential moving average (EMA) is a line on a price chart based on a mathematical formula used to smooth out price action. Due to the greater emphasis on recent prices, the weighting on previous prices is reduced, while the simple moving average (SMA) assigns the same weighting to all price points for the period, EMA reflects the latest price changes more quickly than SMA.
Although the calculation of the EMA indicator may seem prohibitive, the good is that most trading platforms offer auxiliary charts. Therefore, you just need to select EMA from the indicator list and overlay it on the real-time stock.
You can also adjust the number of cycles that should be calculated. Long-term investors typically choose 50, 100 and 200 cycles to track price action over months or years. The 12-day and 26-day EMA have short time periods and are therefore popular with short-term investors.
The EMA indicator is a universal tool for all markets, including stocks, indices, currencies, commodities and cryptocurrencies.
Who invented the exponential moving average indicator (EMA)?
The first article to introduce the concept of EMA was "Predicting Seasons and Trends Using Exponentially Weighted Moving Averages" published in 1957 by Charles C. Holt. The method described in the book provides for the systematic development of predictive expressions for EWMA, which is used by various industries to detect trends and error structures.
In the early 1960 s, the first person to use exponential smoothing to track stock prices was P. N. Haurlan. He is the technical manager of the Pasadena JPL in the United States and has used EMA to design rocket tracking systems. Because he has free access to the computer, he can analyze the stock market at his leisure. At the beginning of his successful application to the stock market, he did not propose an "exponential moving average", but called it "trend value". Later, Haurlan created his Haurlan exponential EMA model. This model plays an important role in promoting the development of the McClellan Oscillator (McClellan Oscillator) and the Summation Index (Summation Index), including exponential smoothing of early fading data.
What does an exponential moving average do?
The EMA indicator can filter misleading daily price behavior and reduce interference by reducing time data lag and avoiding distorted information with small correlation. In addition, it can smooth the price display trend, prompting signals that you may miss. EMA is also very reliable and accurate in predicting future market price changes.
EMA has higher sensitivity, which sometimes makes it more susceptible to false signals. However, EMA is definitely the best choice for traders who are keen on high volatility market trading or intraday trends. Sometimes, it can even be used to determine trading bias: if the EMA on the daily chart shows a strong upward trend, then the strategy of the day trader may be to only trade the market.
The important thing to note is that EMA reacts much faster to price reversals, while SMA tends to lag. Similarly, EMA may be more common in volatile markets.
Guide to the use of Exponential moving averages
Like most other MA indicators, EMA is well suited for analyzing trending markets. If the market is in a stable and strong upward trend, the indicator line will also show an upward trend.
A savvy trader will not only track the direction of the EMA line, but also the rate of change between adjacent lines. For example, as the strong uptrend begins to flatten and reverse, the rate of change between the EMA adjacent bars slowly decreases until the indicator line flattens and the rate of change goes to zero.
Due to the lag effect, the price action should have been reversed at this time. Therefore, observing the continuous decline in the rate of change of EMA can be used as an indicator in itself, thus avoiding the dilemma caused by the lag effect of the moving average.
12-and 26-day EMAs are the most popular short-term average analysis tools, and 50-and 200-day EMAs are used to analyze long-term trends. The EMA indicator is also the basis for smoothing the similarities and differences of the Moving Average (MACD) oscillator and the Price Oscillator (PPO).
Although there are no rules and requirements for how exponential moving averages are used, professional traders prefer to simplify EMA trading:
Trend tracking. Basically uses EMA entirely to track major trends and act on them. As long as the stock closes below the average, the trader will continue to hold the position.
Dynamic support and resistance levels. Like a 50-day or 200-day EMA cycle can be used as a support and resistance range, and traders can determine their respective trading strategies and decisions accordingly.
Moving averages cross. By using two different exponential moving averages, buy and sell signals are obtained. EMA crossover heralds changes in momentum and trend. When the shorter-term EMA crosses the longer-term EMA, it indicates a bullish signal; Otherwise, it is a bearish signal. In many cases, asset prices will approach the EMA line that is farther away after the cross is completed. Usually, the area between the two EMA lines is a good time to enter the market.
Moving averages are easy to use and clear and easy to understand. Traders can draw several different moving averages on the chart at the same time, which is an advantage that many other technical indicators lack. This is why, in conjunction with other indicators, EMA can best identify significant market changes and measure their effectiveness.