Furthermore, an EMA plotted using the time period ranging from 50 to 100 will reflect the long-term trend. Similarly, an EMA drawn using the time period ranging from 20 to 30 will indicate the medium term trend. In this regard, it should be noted that an EMA drawn using the time period ranging from 5 to 14 will show the short term price trend. Theoryįrom the previous discussion, it is clear that an exponential moving average indicates the trend with a small lag. Professional traders can vouch for the fact that a certain amount of lag is absolutely necessary and EMA perfectly fits their requirement. However, a majority of the traders prefers EMA for the simple reason that it does not decrease the lag to the extent of creating too many whipsaws in the trading system. This has led to the creation of several other types of moving averages such as linear weighted, the triple moving average and hull moving average to name a few. Mathematicians have successfully tackled the issue of lag using advanced calculations. Thus, it responds quickly to changes in the price action scenario. This is where an exponential moving average (EMA) can be advantageous.Īn EMA gives more weight to the recent price data. Common sense dictates that better trading decisions can be taken when the lag is brought down to minimal. Since the calculation does not give any special preference to the latest price, the outcome of the calculation will not reflect what is currently going on in the market. However, in reality, there may be situations where unexpected news, announced recently, would have resulted in large price swings. As it can be seen, the calculation gives equal weight to all the closing prices used for the calculation. The two points are now connected to visualize the trend effectively. The same procedure is carried out on the next day to get the next point to be plotted on the chart. The resulting value is plotted as a dot in a chart with time on the X-axis and value on the Y-axis. For example, to calculate a five-day simple moving average, the closing price of the past five days is added and divided by five. A simple moving average is nothing but an arithmetic mean of a set of values. To understand the need to use an exponential moving average, let us quickly refresh ourselves about simple moving average. Why should we use an exponential moving average? The 5 EMA (Exponential Moving average) trading system described below practically solves most of the issues, which are common with simple moving average crossover systems. Thus, practically, it may be of little use to a day and swing trader. However, the moving average crossover system has lots of drawbacks. The system, which involves buying or selling an asset based on whether the short term moving average crosses above or below the long term moving average, is one of the easiest ways of trading in the market. A beginner in the world of trading would definitely come across a simple moving average crossover system.
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