Exponential Moving Average Indicator – Stay on the Right Side of the Trend with the EMA Indicator 

 December 12, 2015

By  Advanced Strategies

Exponential Moving Average Indicator is a simple but useful trend indicator. Moving averages prove very useful when it comes to getting a good sense of the overall direction, the trend that the market is taking. Typically, these moving averages are of two kinds – simple and exponential. They are both relatively similar with subtle differences.

With regard to the former, i.e. simple moving average, it is in essence exactly what it states – a simple average of prices over a designated time period. So for instance, if you have a 10-day time period, the simple moving average will be the sum of the closing prices of asset classes (say forex pairs), divided by 10.

Exponential moving average is similar to simple moving average, with the difference lying in greater emphasis placed on recent prices. This is done because often, past prices end up unduly impacting future prices – as determined by the simple moving average, when that may not factually be the case. Therefore, by taking up the exponential moving average, a better pointer with regard to the scenario in the immediate future can be attained.

The chart below gives you a good pointer on this aspect.
exponential moving average indicator

Image Courtesy: OnlineTradingConcepts.com

Determining the exponential moving average is reasonably simple. First start with the simple moving average as already indicated above. Then ascertain the weighing multiplier which is based on the number of periods in the average. With this in tow, arrive at the exponential moving average.

Exponential moving average and trend lines

Given its emphasis on recent prices, exponential moving average tends to have less lag. At the same time, when it comes to identifying resistance or support levels, a simple moving average would be better suited.

The reason exponential moving average proves suitable when it comes to staying on the right side of the trend is simple as already stated above – its stress on recent prices. If you look at indicators like the MACD or Moving Average Convergence Divergence or Bollinger Bands, they are based on the exponential moving average. Therefore, from a point of view of indicators pointing out trend directions, exponential moving averages prove critical.

Below is a chart to compare the effectiveness of EMA and SMA indicator.

EMA vs SMA Indicator

Image Courtesy: OnlineTradingConcepts.com

Further, when it comes to making a turn, again it is exponential moving averages that do so prior to simple moving averages.

As far as signals on trend lines are concerned, it is true that both simple and exponential moving averages can offer them. Ultimately, it is up to you as a savvy forex trader to gauge the moving average which would be most suited to your trades.

Typically, in strong trades, both simple and exponential moving averages work well, with exponential moving average proving to be a better indicator in the long run. Therefore, when you are looking to get a good grip on the markets for the long term and then strategize your trades accordingly – with a clear objective of remaining on the right side of the trend (essentially one which works best to your objectives), then the exponential moving average with ample foresight will work marvelously well.

Cautionary note

Irrespective of whether you opt for simple or exponential moving averages as your guiding lights for smarter trading, you should not make them the only such source of guidance.

We stress on this aspect because securities – including forex, can end up lying in a particular trade range for a longer than forethought time frame. Under such circumstances, if you simply rely on moving averages for signals, what you will receive will of course be immensely delayed signals, which could definitely lead you onto a path contrary to your trade objectives.

See the chart below, where you can note the manner in which Buy and Sell areas are clearly demarcated in the context of the EUR/USD forex pair.

EMA BuySell SignalImage Courtesy: DolphinTrader.com

Therefore, the objective should always be to mix things up, using exponential (or even simple) moving averages in tandem with other sources of market signals for placing your trades.

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