The Exponential Moving Average or EMA is a basic technical analysis indicator that is useful for determining the trend in the value of an asset. It takes into account the average value of the same during a certain period of time.
Une of the most important instruments that can be used as a cryptocurrency trading strategy is the Exponential Moving Average (Exponential Moving Average) or EMA, for its acronym in English. The EMA is a strategy used to evaluate the trends in the markets. I mean, it allows us display the average price of an asset on the market in a given period.
How does the Exponential Moving Average (EMA) technical indicator work?
As its name indicates, it is a moving average that moves following price variations; that is, it collects the data generated in the last session, while discarding the oldest data in the time series. The EMA responds more quickly to recent price movements than the Simple Moving Average (SMA).
The EMA is an excellent tool if used properly. The EMA does not predict or anticipate any movement but serves to confirm a trend in a moment determined.
How is the EMA calculated?
To calculate an EMA of n periods, we will apply three simple steps:
- Calculate SMA: the value of the simple moving average is calculated by adding the closing prices of the reference periods. This figure is then divided by the number of periods taken (n). That is, the sum of n periods, divided by n:
SMA = sum of the selected periods ÷ the number of selected periods
- Calculate the multiplier to weight the EMA: This factor is determined by the number of periods of the EMA. Therefore, for its calculation, 2 is divided by the number of periods taken plus 1. Therefore, the formula will be as follows:
Multiplier = [2 ÷ (number of selected periods + 1)]
- Finally, calculate the current EMA: here the following formula will be applied:
Current EMA = [Close Price - EMA (previous day)] x multiplier + EMA (previous day)
The calculation of EMA favors the latest prices since it gives them a higher weighting. For example, if we apply the formulas to calculate a 10-period EMA, the weighting given to price would be higher (18,18%). While for the calculation of a 20-period EMA, the weighting would be lower (9,52%).
Usefulness of the EMA indicator
EMAs are variable tools that must be used and combined with other instruments. In order to look for a greater probability of success in the operations carried out.
One of its most frequent uses is as an indicator in a breakout strategy. For example, if we have a trend-following breakout system with the Bollinger Bands and the EMA, we can use the bands for as an indicator. In the event that the price crosses the upper line, we will interpret it as a bullish signal. Where the EMA, which acts as a trend indicator, must also coincide with that same signal.
Another very effective trading strategy is known as Exponential Moving Averages Crossing. Which consists of using the combination of two exponential moving averages, one for the short term and the other for the medium/long term. In this strategy, a signal is created when the shorter moving average crosses the longer moving average from the bottom up. This signal is called long position, and is taken as a buy signal in a bull market. Conversely, if the longer moving average crosses the shorter moving average from top to bottom, it is called short position, and reflects a sell signal in a downtrend market.
However, as with the previous examples, there are many other combinations that we can implement with this great tool, which not only helps us confirm a trend, but also helps us define when we can trade, increasing our chance of profit and reducing the possible losses.
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