The exponential moving average is simply a line that is based on the average of a number of period points. Extra weight is given to the first few points, unlike the simple moving average. The SMA on the other hand has identical weighting on all points.
What is the purpose for adding weight? A quantity of traders feel that SMA’s do not react speedily enough to drastic market movements. To correct this problem, the EMA’s were created.
If you were to enter a 20 SMA alongside a 20 EMA, the exponential moving average will always respond to price movement quicker than the SMA would. There is a disadvantage to this. Because it responds quickly, many false changes in the trend occur.
In a ranging market, this can be very lethal. In a ranging market, virtually all Forex traders pass up the use of any indicator based on the moving averages.
A strategy that is reasonably popular with traders is the EMA crossover. A period of 5 as well as 13 EMA is typically used. The 5 EMA is the lead line, traders buy or sell if it goes above or underneath the 13 line. When the markets are in a solid trend, this strategy does fairly well. In a ranging market, heavy losses will take place.
An additional strategy involves three EMA and utilizes the cross over theory as well. Forex traders pick the EMA of 4, 9 in addition to 18. All three periods depict the short term, long term and mid term trends of a financial instrument.
If both the 9 and 4 exponential moving average lines cross over the 18 EMA, traders buy. In reverse, should both 4 and 9 cross below 18, that is an indication to sell the financial instrument.
While the Ema indicator can be very effective, it takes a skilled hand to truly reap the benefits this indicator offers to traders. While this article has been categorized under currency trading, the exponential moving average can be applied to all financial markets that include commodities and stock trading.