Learning to Measure Exponential Moving Average (EMA)
Do you remember listening to your professor talk about Exponential Moving Average (EMA) during your college years? I, myself, can’t imagine I will be using this price indicator today. Exponential Moving Average (EMA) is also called Exponentially Weighted Moving Average (EWMA). EMA is a product of statistical analysis that is very much similar to Simple Moving Average (SMA), except that more weight is given to the latest data relative to older prices in an attempt to reduce the lag of the simple moving average. Weighing for each older data point decreases exponentially, thus giving much more importance to recent observations while still not discarding older observations entirely. In other words, EMA reacts faster to recent price changes than simple moving averages.
Many believe that it is important to understand how EMA is calculated because by understanding, you can decide on which technical indicator in forex trading is best for you. How to calculate the Exponential Moving Average? EMA is calculated by adding the moving average of a certain share of the current closing price to the previous value. The formula is:
EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) + EMA(prev)
EMA applies a percentage for how much the price action is weighted, depending on the period you are using. Example: 10-period EMA's Multiplier = (2 / (Time periods + 1) ) = (2 / (10 + 1) ) = 0.1818 (18.18%)
With EMA chart, you will be able to determine buy signals as well as sell signals. If the short and intermediate term averages cross from top to bottom the longer term average, then a sell signal occurs. On the other hand, if the short and intermediate term averages cross from bottom over the longer term average, a purchase signal will occur. It is recommended that it is better to use longer term averages if you trade only 2 exponential moving averages in a crossover system.
EMA helps smooth out raw and noisy data like daily prices. If price is growing or decreasing, price data can change very much from every day. One application of EMA is for trend defining. EMA can be used to determine if data is opposing the trend. There is what we call entry and exit system to compare data and check if it supports a trend or starting a new one. EMA is also common to construct other indicators such as the MACD and ADX, especially the 12- and 26- day EMAs. The 50- and 200- day EMAs are used as signals for long term trends. Technical analysts prefer to use the EMA because of its ability to reduce the lag between EMA crosses, which triggers buy and sell for active traders.