{"id":1022079,"date":"2022-09-14T02:08:44","date_gmt":"2022-09-14T09:08:44","guid":{"rendered":"https:\/\/www.tradingheroes.com\/?p=1022079"},"modified":"2024-03-09T10:16:40","modified_gmt":"2024-03-09T17:16:40","slug":"ema-strategy","status":"publish","type":"post","link":"https:\/\/www.tradingheroes.com\/ema-strategy\/","title":{"rendered":"Exponential Moving Average Strategy (with Results)"},"content":{"rendered":"

There are several different types of moving averages out there, but my favorite is the Exponential Moving Average (EMA)<\/strong>.<\/p>\n

In this beginner's guide, you'll learn what the EMA is, how it works and the results of a super simple trading strategy that uses the EMA.<\/p>\n

The Exponential Moving Average shows the average closing price of the previous candles over a specified period of time. It gives more weight in the average to the most recent closing value, and therefore has less lag than the Simple Moving Average.\u00a0<\/strong><\/p>\n

I could start by giving you the formula for how to calculate it, but that's boring and overly complex.<\/p>\n

If you really<\/em> want to know how the formula is calculated, I'll provide that towards the end of this guide.<\/p>\n

But let's start off with something way more practical.<\/p>\n

What is a Moving Average?<\/h2>\n

A moving average is a graph of the average closing price of a market over the last X number of candles\/bars.<\/strong><\/p>\n

Let's use a setting of 10 as an example.<\/p>\n

So on a daily chart, the current moving average value would be the average of the closing prices of the previous 10 days.<\/p>\n

On a hourly chart, it would be the average of the closing prices of the last 10 hours.<\/p>\n

When you're trading, you'll often see the number of candles used in the calculation in parenthesis.<\/p>\n

It looks like this:<\/p>\n

MA (10)<\/p>\n

The Difference Between an Exponential Moving Average and a Simple Moving Average<\/h2>\n

A Simple Moving Average (SMA)<\/strong> takes the sum all of the closes in the range and divides that number by the number of candles in the range, which is 10, in the example above.<\/p>\n

Here's what it would look like in a spreadsheet.<\/p>\n

The number in the bottom right corner is the average of the closes from the last 10 days.<\/p>\n

\"SMA<\/p>\n

An EMA does something similar, but it gives more weight to the closing price of the most recent candle.<\/strong><\/p>\n

Therefore, it lags less<\/em> than the SMA.<\/p>\n

Here's how that looks on a EURUSD daily chart.<\/p>\n

\"SMA
Chart by TradingView<\/a><\/figcaption><\/figure>\n

As you can see, the EMA stays closer to the current price than the SMA does.<\/p>\n

This is why I prefer to use the EMA…most of the time.<\/p>\n

You can also use the the open, high or low, instead of the close, to calculate the EMA.<\/p>\n

Here's what it looks like when I put the open, high, low and close EMAs on the same chart.<\/p>\n

\"Open,<\/p>\n

Interestingly, the EMA of the open and the close are almost identical.<\/p>\n

But the most commonly used price point is the close.\u00a0<\/strong><\/p>\n

Why the EMA is Useful<\/h2>\n

The EMA smooths out the complex price movements on a chart and gives us one simple line, which we can use to develop trading strategies.<\/p>\n

This line shows us the overall trend of the market and gives us a reference point to take trades.\u00a0<\/strong><\/p>\n

When the EMA is used as a trend indicator, pullbacks into the EMA can be great places to enter trades, or add to an existing winning trade.<\/p>\n

Here are some examples of where you could have opened buy trades on the NEM chart.<\/p>\n

This chart uses the 50 EMA (blue) and the 20 EMA (green).<\/p>\n

Notice how using EMAs with different settings can help us take advantage of different phases of the trend.<\/p>\n

When the trend is weaker, the 50 EMA gives is 3 buy points, as shown by the blue arrows.<\/p>\n

As the trend accelerates, the 20 EMA becomes more useful and gives us one entry at the green arrow.<\/p>\n

\"Entry<\/p>\n

EMAs can also be used in conjunction with other indicators to create countertrend, or against-the-trend, trading strategies.<\/strong><\/p>\n

Here's an example of a 100 EMA on a gold chart, paired with the RSI indicator<\/a>.<\/p>\n

Notice that when RSI goes overbought or oversold, price tends to move back towards the EMA.<\/p>\n

This is an example of a countertrend EMA strategy.<\/p>\n

\"Gold<\/p>\n

Which EMA Setting Should You Use?<\/h2>\n

The setting you use will depend on the length of the trend you want to identify.<\/strong><\/p>\n

If you want to find longer term trends, you'll include more candles in the moving average.<\/p>\n

Something like a 200 EMA is a common setting that traders use to identify a long term trend.<\/strong><\/p>\n

Here's a 200 EMA on the BTC daily chart.<\/p>\n

\"200<\/p>\n

As you can see, the 200 EMA smooths out the downtrend and allows us to see that the long-term trend is down.<\/p>\n

For a short-term trend, you'll use a lower EMA setting. A frequently used EMA setting is 20.<\/strong><\/p>\n

This is what the 20 EMA looks like on a chart.<\/p>\n

\"Rivian<\/p>\n

The 20 EMA on this RIVN chart shows that the short-term trend is up.<\/p>\n

So if you want to capture long term trends, use a higher EMA setting.<\/p>\n

If you want to trade shorter term trend, or you want to place trades in fast moving markets, use a lower EMA setting.<\/p>\n

Traders use variations of the settings, depending on the type of market they are looking for and what their backtesting has shown to work.<\/p>\n

Obviously, there are many potential settings that you can use.<\/p>\n

But let's take a look at an actual trading strategy and the settings that are commonly used with this strategy.<\/strong><\/p>\n

I'll also show you the backtesting results from using these settings.<\/p>\n

EMA Crossover Strategy<\/h2>\n

A well-known moving average trading strategy is to trade when a faster moving average crosses over a slower moving average.<\/p>\n

For example, the Golden Cross and Death Cross<\/a> are often mentioned in the mainstream finance media.<\/p>\n

This method usually utilizes the SMA, but the concept is exactly the same.<\/p>\n

Here's a chart of the S&P 500, showing the Death Cross that occurred in March.<\/p>\n

The purple line is the 50 SMA (faster) and the gray line is the 200 SMA (slower).<\/p>\n

\"S&P500<\/p>\n

So when the 50 SMA closes under the 200, you sell.<\/p>\n

When the 50 SMA closes above the 200, you buy.<\/p>\n

If you have an existing position, you close it out and enter a trade in the opposite direction.<\/p>\n

Obviously, there are more details that need to be added to make this a complete trading plan<\/a>.<\/p>\n

So here's a trading plan that I created and tested in NakedMarkets<\/a>, using the 50 EMA and 200 EMA, instead of the SMA.<\/p>\n

Like I said before, I like the EMA better because it tends to be more responsive to price changes.<\/p>\n

You can use almost any platform to backtest this strategy manually, including MT5<\/a>. But NakedMarkets makes it much easier.<\/p>\n

Entry<\/h3>\n