Exponential Moving Average



What is an Exponential Moving Average (EMA)?

An exponential moving average or EMA in short, is also identical to the simple moving average (SMA), except that it adds more weight to the recent data. It can also be called the exponential weighted moving average. The EMA response faster to the current price changes than the SMA.

To calculate an EMA, you need to do the following three steps:

  • Calculate the SMA
  • Calculate the weighting multiplier
  • Calculate the EMA

Below is the formula for a 10-day EMA:

SMA: Sum of 10 period / 10
Multiplier: 2 / (Time periods + 1) means 2 / (10 + 1) = 0.1818 or in percentage 18.18%
EMA: Close – EMA (previous day) x multiplier + EMA (previous day)

A 10-period EMA applies a weighting of 18.18% to the current price and it is also called an 18.18% EMA. A 20-period EMA applies a weighting of 9.52% to the current price [2 / (20 + 1) = 0.0952]. As you can see that by comparing the weighting of these two time period, you will find that the shorter time period is more than the longer time period. Fact is, every time the moving average period increases two times, the weighting decreases by half.

If you need to use a fixed percentage for an exponential moving average, you can apply the under-mention formula to change it to time periods and then input that data as the
EMA’s parameter:

Time Period equals (2 divided by Percentage) minus 1

Example for 5%: Time Period = (2 / 0.05) – 1 = 40.0 time periods

Most traders like to use the short-term averages of the 12-day and 26-day EMAs to form indicators such as the Bollinger Bands. Generally, for long-term trends signals, the EMAs of 50-day and 200-day are used. The chart below shows the difference between the 10-day EMA (blue line) and the 100-day EMA (red line).

Exponential Moving Average

Exponential Moving Average Indicators

Traders who use technical analysis to assist them in their trades find that when applying the moving averages correctly they are very useful and distinctive but if they are not being properly used or wrongly interpreted, they could create havoc. By nature, all the moving averages that are being used in technical analysis are lagging indicators. In this respect, the bottom line for using a moving average is to verify a market move or to show its strength. Usually, the moment a moving average indicator line plotted a change to show a significant move in the trade market, the desirable time of trade entry has already gone. With an EMA, it can solve this problem to a certain extent. As the EMA computation adds more weight on the current data, it hugs the values quite tightly and therefore responds faster. This is good when an EMA is used to pin point a market entry signal.

EMA are suitable for trending markets. It will indicate an uptrend when the market is firm and prolonged uptrend and also the opposite for a downtrend. Beside monitoring the direction of the EMA line, a vigilant trader will also need to pay attention to the movements of the price action from one bar to the next. For instance, as the momentum of a strong uptrend starts to flatten and retreat, the EMA’s rate of change will start to taper until the period the indicator line flattens and the rate of change is zero.

By this point, due to the lagging effect, the momentum should have already retreated. It then follows that by monitoring a consistent tapering in the EMA’s rate of change, it could be used to counter the problem caused by its lagging effect.