Trading in the stocks has developed an important source of earnings for several people. There has been an increase in demand for the development of specific algorithms and indices to predict the trends in the market. Yes, it may seem like rocket science at first, but in this piece, we shall equip you with the basic knowledge needed to trade using specifically the EMA strategy.
What Is The EMA Strategy?
First and foremost, a simple definition of a moving average is an indicator used in the technical analysis used to analyze price trends. In the trading industry, specifically, we do have several strategies aligned. And one of the oldest ones is the Exponential Moving Average Strategy, the EMA. The ema indicator is used to identify the top-tier trend in the market. It is basically a line on a price chart that smoothens out the price action over some time by implying a mathematical formula. The EMA puts more emphasis on the recent prices in the market. Therefore EMA is measured one of the greatest dependable. The other type of moving average strategy is the Simple Moving Average.SMA.
The EMA is very diverse and can be used in all markets, including, indices, forex, currencies, stocks, and cryptocurrencies. Because of this; it works for any time frame.
How It Works
By comparisons of prices, the EMA tries to reduce the noise and confusion on the rates and smoothens them by producing means hence eventually revealing the trend. This trend is used as a forecast indicator of the present and also the future changes in the market price.
1. Calculate The EMA
Before even commenting on the EMA, you must first assess the SMA. It is the addition of the closing prices for the number of periods, divided by the same amount of periods. For instance, a 5-day SMA is the sum of the closing prices for the past five trading days, divided by 5.
Next, you calculate the multiplier for weighting the EMA following a simple formula; [2 / (time period selected +1)]. So for the example above he EMA becomes [2/ (5 + 1)] = 0.333
Then we calculate the current EMA using; [closing price- EMA of the previous day] x multiplier + EMA of the previous day.
2. Interpret The EMA
Here you need a little bit more of insight on the EMA interpretations to carry out an examination. For an up-trend in the current market being analyzed, the EMA indicator will show an up-trend and vice-versa for a down-trend. Not only should you pay attention to the direction of the trend but also the rates of change from one bar to the next. Be sure to check on the lags on the price action as this may also reveal the result of the final trend.
3. Trade Abiding To The Trend
Lastly, after you have done all the necessary calculations and have done a comprehensive analysis of the price action, you can now trade. Remember, trading by EMA does not predict the market, but it reacts to the current market.
Places The EMA Trades Best
Considering it is a fast-moving strategy, it is equally applied in the trading of fast-moving markets. Markets such as forex and currencies are best suited, although it can be used in conjunction with other indicators as well.
Advantages of Using EMA
Considering this strategy applies more weight to the most recent price bars in the market, it reduces the lag in time data and avoids distortions from irrelevant data.
Its reactions to price changes are quicker as compared to the SMA. Meaning this could signal a trader to leave a particular trade fast to avoid eventual losses on time and money.
Its calculation is very straightforward and easy to understand.
Limitations To The EMA
The fact that the EMA reveals trends in reference to past information limits it to only present and past. Therefore it is not very useful in cases one would like to predict future pricing and trend outcome. It does not take into account the external current events that may affect the trade in the future; therefore, in some cases, it becomes a high-risk trading strategy.