This post is written by Jet Toyco, a trader and trading coach.
There are a lot of variations of the Moving Average such as the:
- Simple Moving Average
- Weighted Moving Average
- Hull Moving Average
- Arnaud Legoux Moving Average
So, what makes Exponential Moving Average special this time?
Some of you might even be wondering…
“What is Exponential Moving Average?”
“How to calculate Exponential Moving Average?”
“Must I remember the Exponential Moving Average formula?”
On top of that, what’s the “best” Exponential Moving Average period to use?
In today’s guide, I’ll make sure to answer all of your questions.
So let’s get started…
What Is The Exponential Moving Average And What Makes It Different From Simple Moving Average
The calculation of the Simple Moving Average is simple.
Step 1: Determine the closing price depending on your chosen period
For example, you’re using a 10-period Simple Moving Average on the daily timeframe.
Determine the closing price over the past 10 days.
Past ten closing days on KIRK daily timeframe:
Next is to…
Step 2: Add all of the closing prices
Sum of all closing prices on KIRK daily timeframe:
As you can see, adding up all of the closing prices for the last 10 bars gives you 13.26.
Step 3: Divide it with your chosen period
Basically, we divide 13.26 to 10 (which is your chosen moving average period).
You get a Simple Moving Average value of 1.33.
Final moving average value on KIRK daily timeframe:
Simple, am I right?
Let’s talk about Exponential Moving Average (some of you might know it as Exponential Weighted Moving Average).
What is Exponential Moving Average in trading and how to calculate Exponential Moving Average?
The Exponential Moving Average formula is quite more complicated.
It’s quite a handful.
However, you don’t have to worry about its formula or if there’s an Exponential Moving Average calculator to use.
Simply plug and play the indicators from your trading software and you’re all set.
The purpose of the Exponential Moving Average formula is to give it more “weight” and reaction to the current price.
Making it less of a “lagging” indicator.
You can clearly see their difference here.
EMA and SMA difference on KIRK daily timeframe:
So with that said…
Let’s immediately dive in and determine why a lot of traders lose money using Exponential Moving Average…
Why You Lose Money With The Exponential Moving Average
When I first learned about technical indicators, I was totally amused by them.
I felt powerful having them on my chart and that the markets should bow down and respect those indicators.
But here’s the truth…
Technical indicators such as the Exponential Moving Average aren’t crystal balls, they are tools!
And what do tools do?
They help you make certain things easier and get things done of course!
It’s the same thing with the Exponential Moving Average.
You must use the indicator in a way that wouldn’t overcomplicate your analysis and trading and use them when appropriate.
However, a lot of traders use the Exponential Moving Average the wrong way such as…
Using the indicator along with other correlated indicators
Sorry to break it to you…
Having more indicators on your chart doesn’t guarantee you a winning trade no matter how many stars aligned.
Take the MACD for example.
Using it along with the Exponential Moving Average is pretty counterintuitive.
Because the MACD is just a combination of Exponential Moving Average formulas!
MACD formula on EURUSD daily timeframe:
So if the Exponential Moving Averages on your chart is showing a bullish signal, and your MACD indicator is showing a bearish signal…
It’s like you’re having an EMA civil war on your chart, and you’re left paralyzed on what to do next.
What should you do then?
Simple, choose one indicator for one purpose.
- One indicator for trend filter
- One indicator for entry trigger
- One indicator to determine your initial stop loss
- One indicator to determine your trailing stop loss
I’ll explain this more in the later sections, but for now, keep this in mind:
Trading in range markets
Here’s the bottom line…
Exponential Moving Averages are meant to be used in trending market conditions.
Because when you use this indicator in ranging markets…
Whether you use the 10, 20, 50, 200-period EMA, it doesn’t matter.
Using EMAs in a ranging market on CADCHF daily timeframe:
Because the price will disrespect and ignore them over and over again.
Instead, only use Exponential Moving Averages where they are respected, which is in trending markets.
Using EMAs in a trending market on EURUSD daily timeframe:
Can you see the difference?
Pretty noticeable, right?
However, this isn’t enough.
Because another mistake traders make when using the Exponential Moving Average is…
Using shorter periods on volatile trends
I know, you like to experiment and try out different indicator settings.
And I know that you may not have the patience to deal with long-term trades.
So what do you do?
You tend to scalp the markets on the 1-minute timeframe or use very short indicator parameters such as 5 and 10-period Exponential Moving Average.
But sometimes, this can do you more harm than good even when using it in a trending market.
Short-period EMAs in a volatile trending market on INRUSD daily timeframe:
“What? I thought Exponential Moving Averages are best used in trending markets?”
“Why isn’t it still working?”
Let’s break down what’s happening here.
You’re using a shorter period Exponential Moving Average.
At the same time, you are trading in a volatile market.
That doesn’t match up, doesn’t it?
Shouldn’t you use longer periods when markets are volatile…
Longer-period EMAs in a volatile trending market on INRUSD daily timeframe:
And use shorter periods when markets are parabolic?
Tight-period EMAs in a parabolic trend on USDTRY daily timeframe:
Now that’s better.
So at this point I’m sure you have this burning question on your mind right now:
“Which Exponential Moving Average period to use?”
“Should I use the 69-period Exponential Moving Average?”
“How about 72-period? Which is the best?”
You’re in luck because that’s what we’ll talk about more in detail next…
How To Know Which Exponential Moving Average Period To Use
If I were to make an article: Top 10 most asked questions in trading of all time…
This question of trying to know which Exponential Moving Average period is the best definitely makes it into the list.
But here’s the truth:
Even if I give you the answer, it wouldn’t make a single improvement on your trading.
Because you’re too focused on “what” is the best period, instead of “why” should you use a certain period.
What do I mean you may ask?
It means that you should know the context of this concept and choose an Exponential Moving Average period yourself that you think is relevant to your trading method.
And the best way to get started with this is to know the characteristic of the trend you are looking to capture:
- Weak trend
- Healthy trend
- Strong trend
Then finding the “appropriate” Exponential Moving Average value to capture those types of trends.
Let me show you…
These types of trends are essentially long-term trends where volatility is huge and there are a lot of whipsaws that looks something like this:
Weak trend on EURJPY daily timeframe:
Again, it wouldn’t make sense if we use a short Exponential Moving Average period such as the 10 and 20-period right?
Short-period EMAs in a weak trend on EURJPY daily timeframe:
Instead, if you want to ride weak (but long-term) trends, you want to be using between 100 and 200-period Exponential Moving Average period.
Long-term EMA period in a weak trend on EURJPY daily timeframe:
I said between because it doesn’t matter whether you pick 120, 199, or 123 period, but the concept is that the period is large enough to capture these types of trends.
Healthy trends or medium-term trends are fit for traders who are looking to find slow but steady gains especially trend-followers.
Healthy trend on EURJPY daily timeframe:
As a trend follower myself, seeing a healthy trend is beautiful should be taken advantage of!
Nonetheless, using between 50 to 100-period Exponential Moving Average to capture a healthy trend is a “relevant” period to use.
Medium-term EMA period in a healthy trend on EURJPY daily timeframe:
Strong trends are mostly markets that have been hyped up by a lot of traders and the media, and where a lot of new traders hop in.
Strong trend on BTCUSD daily timeframe:
These short-term trends shouldn’t be considered as investments as they could snap back and reverse anytime.
But you, as a momentum trader can highly take advantage of this by using an Exponential Moving Average period between 10 and 20.
Short-term EMA period in a strong trend on BTCUSD daily timeframe:
There you go!
An objective way of choosing which Exponential Moving Average period to use yourself.
Again, you determine what type of trend you want to capture and use the relevant period for them.
At this point you might be thinking:
“Hmm, sounds good, but you haven’t really taught me how exactly I should use the Exponential Moving Average to enter my trade.”
But everything you’ve learned so far comes down to the next section.
Which is—how to exactly use the Exponential Moving Average to enter and exit your trades.
Ready for the grand finale?
Then keep reading…
How To Use Exponential Moving Averages Like A Pro
For most traders, the Exponential Moving Average is just a regular indicator to filter and exit trades.
But as someone msyelf who’s been using it for so many years…
I’ll share with you how versatile this indicator can be and how only using this indicator is enough
Let’s get right into it!
How to use the Exponential Moving Average as a trend filter
This is probably the most popular way to use Exponential Moving Averages.
But a question not a lot of traders ask is:
Do you really need a trend filter?
The answer is yes!
If you’re planning to take both long and short trades such as in the Forex market.
Using EMAs as a trend filter on GBPUSD daily timeframe:
Basically, using a trend filter can be your main switch whether you want to long or short the markets!
How to use Exponential Moving Average to enter trades
Notice how I’ve emphasized that the price should be respecting the Exponential Moving Average throughout this guide?
Because that’s exactly where you can objectively time your entries since Exponential Moving Averages are “areas of value” throughout different types of trends.
So how do you exactly time your entries then?
First, wait for the price to close below an Exponential Moving Average that has been respected at least two times.
Two tests in the 20-period EMA on NZDUSD daily timeframe:
Wait for the price to close back above that Exponential Moving Average.
The price closed above the 20 EMA on NZDUSD daily timeframe:
Then enter the trade at the next candle open.
The price closed back below the 20 EMA on NZDUSD daily timeframe:
Pretty simple and objective, right?
How to use the Exponential Moving Average to exit trades
The best part about the Exponential Moving Average is that it’s a very versatile tool.
It means that the method of how you enter your trades could be the same as how you exit them!
Which is to simply wait for the price to close beyond the Exponential Moving Average.
20 EMA trailing stop loss on USDZAR daily timeframe:
This makes it a reliable trailing stop loss as you don’t put a limit to your profits.
But then again…
Make sure you know what type of trends you want to capture, then base your Exponential Moving Average period trailing stop from that!
Use Exponential Moving Averages in strong markets
Here’s the truth:
Market conditions change all the time.
Therefore, not all strategies work all the time as well!
So when you’re in a losing streak, instead of asking yourself:
“Are the techniques I’m using with the Exponential Moving Average working?”
“Am I trading in the right market condition?”
Because sometimes it’s not the techniques and indicators that aren’t working, but the market condition itself!
You’re probably wondering:
“Cool, how do I find strong markets to trade with the Exponential Moving Average then?”
Let me show you.
If you trade the Forex market, you want to consider using the currency strength meter.
It tells you which pairs are strong and weak so that you can “pair” them together to trade them.
As you can see, the strongest pairs are the JPY and CHF pairs, while the weakest ones are the NZD and GBP pairs.
So you can consider trading GBPJPY, or NZDCHF for example.
Now, I won’t go through a ton of details on how to make your own currency strength meter.
So I suggest reading this article here: The Essential Guide to Currency Strength Meter
Unlike the Forex market, the stock market has thousands of stocks to choose from.
So in this case, I highly suggest you use a free screener tool such as Finviz.
At first, it can be intimidating as if you’re in an airplane cockpit.
But remember our goal?
Our goal is to look for strong stocks to trade, so you’d only want to only pick the settings that meet our goal and ignore the rest.
Nonetheless, you can consider using these settings:
Now, once you have your results (which shows the top strongest stocks for the year so far), you’d want to trade the top 20 results in the list!
So if you have a 50-period Exponential Moving Average bounce setup on GME and AMC for example…
Then you’d want to make sure to enter GME first, then AMC after.
In the end…
What you’re doing here is to strategically position yourself on strong markets which would make the Exponential Moving Average much more effective (without changing the way you trade).
If so, let’s do a quick recap on what you’ve learned today…
- Compared to the Simple Moving Average, the Exponential Moving Average’s calculation is more reactive and has more weight on the current price
- You can almost immediately find better results when trading the Exponential Moving Average with the trend and also not using it with correlated indicators
- The period you choose on your Exponential Moving Average should depend on what type of trend you are looking to capture (strong trend, healthy trend, weak trend)
- The Exponential Moving Average is a versatile technical trading indicator for filtering trends, entering your trades, and trailing your stop loss
There you go!
I hope that you’ve learned a lot in today’s guide, but here’s what I want to know from you…
What are the different types of Moving Average you’ve used?
Also, what period do you usually use?
Let me know in the comments section below!