EMA Crossover Strategy
The moving average indicator is a popular tool used by many traders. As the name suggests, the moving average indicator plots the average price over a specified period of time known as the look back period. When trading the moving averages, the guiding principle is that traders use two moving averages, a long term moving average and a short term moving average. When the short term moving average is great than or above the longer term moving average, it is regarded as prices being in an uptrend. Likewise, when the short term moving average is below the longer term moving average, prices are considered to be a downtrend. There are many trading strategies and even expert advisors that are built around the moving average crossover strategy and this makes it easy for beginners to start trading the markets.
The EMA crossover strategy makes use of two moving averages which are exponential moving averages. Unlike a simple moving average where prices are averaged over the look back period, the exponential moving average gives more weight to the most recent price. This gives the EMA a slight edge as the prices that are averaged take into consideration the most recent or current volatility in the markets.
How to trade with the EMA Crossover Strategy
For starters, there are different EMA look back periods that can be used. Most traders often fall prey to the myths of using a ‘magic’ EMA setting. For example, a 55 period moving average is often used because traders believe that 55 is a Fibonacci number and thus tends to offer some kind of edge to the markets. In reality, there is no magic number setting as far as the moving averages are concerned and it is simply logic when you want to find the ideal EMA crossover settings.
Exponential Moving Average Crossovers
For the daily charts and traders who wish to trade a short term swing position, using a 5 period EMA as the short term and a 10 period EMA as the long term will allow for traders to enter and exit trades every few days.
Likewise, when trading on the weekly charts, using a 7 period short term EMA and a 14 or 21 period long term EMA is also beneficial.
The logic behind these EMA numbers is that when trading off the daily charts, traders can go long or short when the 5 day average price is trading above or below the 10 day average price. Likewise, with a weekly chart, traders can be taken depending on how the 7 week average price behaves in relation to 14 or 21 weeks.
An important aspect to understand about moving averages is that some EMA settings are more important than others. For example, a 200 day EMA, 100 day EMA and 50 day EMA are the most commonly watched EMA settings and therefore it pays to remain cautious to these EMA’s in particular.
Long positions are taken when the short term exponential moving average crosses above the long term moving average. In trading jargon, this is referred to as the Golden Cross. Stops can be placed at the lowest low prior to the Golden cross while trades can be exited at a specified number of pips or when an opposite sell signal occurs.
Short positions are taken the short term exponential moving average crosses below the long term exponential moving average, which is referred to as the Death Cross. Stops are placed at the highest high while exits can be managed by setting a specified number of pips or exiting when an opposite signal occurs.
The chart below shows a 5/10 exponential moving average applied to a daily chart with the arrows showing the Buy/Sell signals.
5/10 EMA Crossover Strategy
Why trade the EMA Crossover strategy
Although overhyped and often written off, the EMA crossover strategy is actually one of the very few trading strategies that has stood the test of time. Most traders tend to give up on using this strategy due to incorrect money management and/or pulling the trade trigger a bit too early. Combining the EMA crossover strategy alongside an oscillator or candlestick patterns can however help traders to minimize risk and also trade only the best set ups.
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