The use of indicators has improved trading performance exponentially. It allows a trader to see the unseen and enables more sound decisions when trading. Among the most commonly used indicators in trading is the EMA or Exponential Moving Average. In this post, we’ll provide you with everything you need to know about the EMA indicator and how to increase your potential profits using it.
(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings. In fact, Around 68% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)
What is an EMA?
The EMA or Exponential Moving Average is a trading indicator that makes use of recent data levels and points on a chart. It is the average price per specific period or range of time. In addition, the EMA is also termed as “Exponentially Weighted Moving Average” since it focuses mainly on the recent price levels on a chart. EMA is not to be compared with SMA or “Simple Moving Average” since SMA focuses more on observations in a given period. The EMA is among the oldest yet most reliable indicators used by many traders and it is a great tool to identify entry and exit points.
Computation of the EMA is done in three steps. The first step is to determine the SMA, followed by the weighting multiplier, and then the EMA through a given formula.
The SMA will be computed by simply finding the average price over a specified range. The specified range will be dependent on the traders’ preference. Say the trader wants to use a range of 20 days, the SMA will be computed by summing up all the closing prices from the last 20 days and divide it by 20.
As for the weighting multiplier, it is calculated using the equation, K=2/(n+1). Where “K” is the Weighting multiplier and “n” is the preferred time period. Say the preferred time period is 20, the equation for the weighting multiplier would be as follows: K=2/(20+1). Therefore, the weighting multiplier for a period of 20 days would be .095 or 9.5%.
Lastly, the EMA is calculated using the formula:
EMA= (Current Price x K) + [Previous EMA x (1-K)]
As an example, for a given period of 20 days and a current price of $3.5, the computation for the EMA would be:
EMA of day 19 = seeded price (current price)
K = .095 (from previous computation)
EMA of day 20 = (3.5 x .095) + [3.5 x (1-.095)
= .3325 + 3.1675
As another example, say we have the following given. 9 days with the current price of $5 and the previous EMA of 4.6.
K = 2/(9+1)
EMA9 = (5x.2) + [4.6 x (1-.2)]
= 1 + 3.68
The EMA computation can become a challenge to extract since it involves a few equations and accuracy is very important. Fortunately, broker platforms today are equipped with tools and settings where the EMA can be easily extracted and drawn in any chart.
To use the EMA indicator on the eToro platform, simply login to the eToro chart and click on the settings tab located on the upper right corner of the dashboard. Press the “Settings” tab and be directed to the set of tools available. Click the “Studies II” tab and click on the “Moving Average” tool.
As soon as you click the “Moving Average” tool you’ll be directed to a form where you can fill out specific details for the Moving average. To choose the EMA indicator, choose “Exponential” from the “Type” dropdown menu. Specify any desired period on the “Period” form and hit “Create” to show the indicator on the chart.
The EMA on eToro can be generated multiple times and can have different colors for easy reading.
What Does the EMA Tell You?
The EMA when plotted actually shows the best exit and entry points on a chart. The line that connects the EMA points serves as a bounding line or a fence that separates buying and selling areas on a chart. In addition, the EMA indicator can also be used subjectively to identify stop loss points and optimum target prices in a chart on any range. While the use of a single EMA indicator on a chart can already make trading more efficient, combining multiple EMA indicators with a different range would further improve trading accuracy. Furthermore, crossing EMAs are often considered as a reliable exit or entry point by most traders.
Whenever the price is above the EMA line, it is usually interpreted as a good sign since the trend is expected to move upwards. Whereas, if the price is located below the EMA line, the trend is moving downward.
Among the most quoted or used EMA’s on trading is the EMA 12 and EMA 26 is usually paired with other indicators such as MACD, RSI, and even PPO (Percentage Price Oscillator) to further improve accuracy in estimating entry and exit points.
How to Implement EMA Indicators on an Actual Trade
Implementing EMA indicators on a chart is very much straightforward. Simply activate the EMA indicators through the steps mentioned above and choose your preferred EMA range. For the following examples, we’ll be using EMA12 and EMA26. The EMA12 will be represented by the red line, while the EMA26 will be represented by the blue line on the chart. The ellipses display the possible buy points or sell points where both the indicators cross or intersect.
On this first example with the asset – Apple, the EMA12 and EMA 26 indicators provide a visible view of the best entry and exit points on the chart. Whenever the EMA12 indicator crosses the EMA26 indicator, either a buying or selling signal is confirmed.
For buy-signals on this chart, the EMA12 indicator is always above the EMA26 indicator. On the other hand, the best sell-signals would be when the EMA26 indicator is above the EMA12 indicator.
Here’s another example for implementing the EMA indicator on a chart using two EMA range.
On this second example from the asset – Amazon, also makes use of the EMA12 indicator and the EMA26 indicators. On here, the ideal buy and sell points are also enclosed with ellipses and arrows.
Our Final Thoughts
The EMA indicator is an excellent tool to use for trending markets. It allows a trader to identify safe and low-risk entry and exit points on a chart. The best thing about EMA indicators is that it is easy to use, modify, interpret, and can be used on any range – whether on a minute chart, hourly, daily, weekly, and others.
Depending on how the EMA indicator is used, it can match any trading strategies such as trend-following, position trading, swing trading, and others. For a trader who relies on technical analysis and historical data, the EMA is an essential indicator to every chart.
Making use of the EMA indicator to increase potential profits is certainly achievable provided there is a good understanding of the right range and settings for the indicator. To further improve assumptions and estimates regarding the ideal entry and exit points on a chart using the EMA indicator, it is best to use it with other indicators as confirmation. Other indicators to use with the EMA include RSI, MACD, Volume, and retracement indicators. These additional indicators would reinforce decisions when trading and would provide more accurate points on a chart.
To master the EMA indicator, simply create a virtual account on eToro and trade on a real-time market with real stocks. By practicing the use of EMA indicators on a real-time market, not only will you be able to gain experience and proficiency in using the indicator but you can also get yourself familiar with how your specific stocks or assets move in the market.
Good luck and enjoy!
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