Exponential moving average

Using the EMA in trading means that it adapts more quickly to changes in price action, which is an advantage over the simple moving average. As more weight is given to the recent price data and less to that which occurred earlier in the trading day, this makes it more sensitive to any change in price data and, theoretically, better for understanding in which direction the price may head next.

The exponential moving average therefore helps to influence traders’ decisions in the exact moment that they place a trade based on the exact price movements, as opposed to what was happening on trading charts​ in the past.

This higher weight of recent price data is useful when analysing volatile markets, where there may be abrupt price changes. It is particularly useful for identifying trends and recent swings on price charts to highlight trading patterns​. It also means that there is less of a lag, as the EMA instead reacts quickly to price changes. Therefore, developing an exponential moving average strategy is great for traders who favour short-term strategies, such as day trading in fast-moving markets.

Unlike the simple moving average​​ (SMA), which is a calculation of the average price of a security over a certain length of time, the EMA gives more weight to the most recently occurring prices. This is the major difference between the moving averages, and it also explains why the EMA is preferred by many traders, as it is more responsive than the SMA. However, as with most technical indicators, the EMA works better when used with its component rather than by itself, as the EMA alone cannot guarantee success.

In order to learn how to calculate the exponential moving average, the simple moving average should be calculated first to get the initial EMA value. This will then lead you to finding the exponential moving average equation.

To find the simple moving average, you must find the average number of the past data points, which are often past closing prices. If you were seeking a security’s 50-day SMA, the closing prices of the past 50 days would be added together, then divided by 50.

Secondly, calculate the the weighting multiplier (or smoothing constant). This happens by dividing 2 by the number of time periods, plus 1.

Thirdly, calculate the EMA for each day between the initial EMA value and the current day, using the price, the multiplier and the EMA value of the previous time period.

When a trader is using an exponential moving average indicator within their strategy, they may choose to buy when the price dips near, or just below, the EMA line. On the other hand, when the EMA is falling, traders may choose to sell when the price is rallying towards, or just above the EMA.

The EMA can be an indicator for support and resistance levels​. This is because support and resistance levels are dynamic and constantly evolving, due to the fact that they’re based on more recent price action​. When the EMA is rising, it is supporting the price action, while the falling EMA is providing resistance to positive price action.

However, a key drawback of the exponential moving average is that it is based on historical data, so it cannot predict future price movements. Furthermore, the EMA can also be prone to false signals, such as false positives and false negatives, meaning that it could mislead traders. By interpreting trendlines​​ based on historical data, traders may make decisions based upon the conclusion that the trend will repeat itself.

By registering for an account, you can take advantage of our charting features, including a wide range of technical indicators. Both the SMA and EMA, along with a weighted moving average indicator, are available to incorporate within your trading strategy on our award-winning online trading platform, Next Generation. You can also use our drawing tools to add support and resistance levels, trendlines, channels, Fibonacci retracements and other price projection tools. You can register for a Sign Up first to practise with £10,000 worth of virtual funds.

Simply choose your product between spread betting and CFDs​, choose the market that you would like to trade and a particular asset, and add the EMA indicator to your trading chart through the drawing tools section.

The exponential moving average is a valuable tool for traders to help identify trends of a financial instrument over a period of time. By giving more weight to recent price movements rather than equal averages like the simple moving average, a trader may be able to account for a higher degree of subtlety within the price action. However, as it is based on historical data, it is not a credible source for future predictions and traders can be misled by false signals. Therefore, it should be used in conjunction with other forms of technical and fundamental analysis when building an efficient trading strategy​​.