EMA Indicator

Moving averages are an integral part of technical analysis. While moving average, most people refer to simple moving average or SMA, there is another moving average which is Exponential Moving Average (EMA).

To overcome the limitations of SMA, this indicator was developed and this article will help you understand how this indicator works.

The article will be a detailed guide about EMA, its calculation, workings, how to read the indicator and use it, and a lot more that you want to know.

Stock Analysis using EMA Indicators

Calculate and check out EMA and understand the current sentiment of the stock and make your investment decision.

What is EMA Indicator?

EMA indicator is the Exponential Moving Average Indicator which is used for technical analysis of different investment instruments such as stocks or commodities and others.

It is a weighted moving average rather than a simple moving average that prioritizes the recent prices of the security more than the earlier ones.

So, it assigns more weights to the recent prices to find out the price trend over a particular period.

How does the EMA indicator works?

To understand how EMA works, you need to understand how it is being calculated. While you do not have to calculate it while using the EMA indicator to understand its functioning, you need to understand the calculation behind it.

So, EMA = {Kx(C-P)}+P

Here,

K = Exponential Smoothing constant, which applies the right weight to the prices as per their chronology, by using the number of periods mentioned in the MA.

Therefore, K = 2/(N+1)

So, if you take 10-days EMA, then the weighting multiplier (K) would be = 2/(10+1) = 0.1818 or 18.18%. So, K would change as you change the EMA period.

This indicates that when the EMA is for a shorter period, the weights will be more, while a longer period of EMA will bring down the weights.

C=  Current market price of the asset

P = EMA of the previous period (In the case of the first period, SMA is used for calculation)

So, EMA is determined by using the higher weights for the most recent prices of the stock. This helps in predicting price trends more accurately as it prioritizes the recent market prices more.

How to read and use the EMA indicator?

There are mainly three objectives to read and use the EMA indicator for –

Anticipating Trend

EMA indicator works on similar lines to SMA and you can understand its functioning if you understand that of SMA.

For instance, if the EMA rises and the price is just below the EMA or near it, you can consider buying the security while on the other hand, if the EMA falls, and the price lingers just over the EMA, then consider selling the securities.

So, this way you can understand and anticipate the trend of the asset or the overall share market.

Using EMA as Dynamic Support and Resistance level

Usually, all Support and Resistance Levels you see are static. They do not correspond with changing prices. However, with 50-days and 200-days EMA, you can figure out dynamic support and resistance level, using the moving midpoints of these two EMAs.

If you can recognize the dynamic zones which are helping (support) and opposing (resistance) the price movement, you can easily figure out the entry and exit points as well.

EMA Crossover Buy and Sell Signals

Using 2 EMAs you can also figure out the buy and sell signals. Yes, you can make use of a 50-day EMA and a 20-day EMA, or 10-day EMA.

The crossover of these two EMAs will help you understand when to buy and when to sell. When the price is above the EMA you have chosen, you can remain on the buy side, while it falls below that EMA level, you can consider selling the assets, except if the price is the EMA upside.

While the 3 timeframes mentioned above for the crossover strategy are the most commonly used, there are multiple time frames that you can put to use as per your trading strategy and tenure.

If you are up for long-term trading, then you can make use of 100-days, 200-days EMAs as well while for short-term trading, 10-days, 20-days, or even 5-days EMAs are suitable.

Moving Average Ribbons with EMA

One of the concepts of moving average is ribbon formation. It can be done easily with multiple EMAs and helps in predicting price trends and other factors about trading securities and the overall market.

If you want to make a moving average ribbon you have to plot multiple moving averages of different time frames on a technical chart having the price of the asset you are tracking, simultaneously.

Usually, more than 8 moving averages are ranging from a 2-day moving average to even a 400-day moving average. However, you can change these moving averages according to your investment strategy.

While moving average ribbons can be built with SMA as well, EMAs give more accurate results.

One thing you need to keep in mind while making a moving average ribbon is that, if you are using EMA, then use only EMA, for all the time frames, and if you are using SMA, use only SMA, don’t mix both the moving averages for making ribbons.

A reversal can be anticipated around the corner if all the EMAs in the ribbon converge to a single point or close to it on the price chart.

It can also indicate the weakening of the trend which is a loss of momentum. Conversely, if the moving averages are going away from each other, then the trend is gaining momentum.

Another thing you can understand from these ribbons is the price trend.

There is probably a downtrend if the moving averages of shorter time frames are crossing below the MA of the longer time frame and when the opposite happens, that is shorter time frame MAs cross longer Mas from above, then the uptrend is around the corner.

Why use the EMA indicator?

EMAs have multiple benefits for traders and are thus one of the most used technical indicators across the globe. Here are some of the most important benefits to know –

• EMA can be used across asset classes. It can be stocks, commodities, currencies, cryptocurrencies, or others, you can use EMA for anticipating the price trend of the assets you are trading.
• EMA acts faster than SMA when there are robust price movements. This helps in identifying the price trend quickly compared to SMA. This is due to the fact that they are weighted moving average and respond faster to price changes.
• EMAs can be put to use as support and resistance levels as well.
• You can use multiple time frames for EMAs
• Moving average ribbons are built more accurately with EMAs than SMAs.

Limitations of EMA Indicator

While one set of traders believes that putting more weight on the recent prices helps in a better understanding of recent market trends, however, other traders think that it may lead to inaccurate determination of trends.

Similarly, some traders believe the current market prices are accurate and the market is efficient, while others think that historical prices are important to analyze to predict the future market more accurately.

Conclusion

While there are mixed thoughts about the Exponential moving average indicator or EMA indicator, there is no doubt that this indicator is one of the best for indicating market trends and asset price trends.

Not only that, but this moving average indicator also acts like support and resistance levels, and helps in identifying buy and sell points too.