What if we told you that EMA trading can help you gain an edge in crypto trading? Yes, you heard that right. We are here to let you know how you can incorporate this tool while trading.
Navigating the volatile cryptocurrency market without a plan is risky, especially for beginners. And just to mention, seeing the sharp fluctuations in the value of your portfolio can be stressful.
It’s challenging to make precise trading judgments when things seem hazy. Technical analysis is useful in this situation as it may predict future price movements by seeing patterns in past data. This is where a trader can consider using Exponential Moving Averages.
The Exponential Moving Average (EMA) is one such frequently used indicator. To brief on what an EMA is, EMAs smooth the price charts. It uncovers underlying patterns by removing noise.
In this article, we will look into EMAs for trading in depth. What are EMAs? Types of EMA trading techniques? How can EMAs help people make better-informed decisions? Technical indicators like the EMA indicator. Read on to know mor
What Is Exponential Moving Averages (EMA) In Trading?
Exponential Moving Averages, in short EMA trading, is a type of technical analysis indicator used by traders to evaluate market patterns and discover possible trading opportunities. Unlike SMA (Simple Moving Averages), EMA places more importance and weight on the most recent data items, thus making it respond vigorously to recent price fluctuations.
Using the EMA trading strategy, traders can identify the entry and exit points, thus amplifying their prospects of profitable trades. Trading EMA is more relevant as a short-term trading strategy.
The formula for calculating EMA is
EMA today = (Price today * (2 / (N + 1))) + (EMA yesterday * (1 – (2 / (N + 1))))
Where:
- EMA_today is the current EMA value.
- Price_today is the current asset’s closing price
- N is the selected term/number of days for the EMA.
- EMA_yesterday is the EMA value of the prior day.
In the following section, we help you understand the types of EMAs. We also portray how EMAs respond to changes in price using pictorial representations.
Are There Any Limitations To Trading EMA?
EMA could be a great strategy for recognizing patterns and determining entry/exit points, but it also has limitations. Moreover, the selected EMA period significantly impacts its efficacy and is sensitive to the type of asset and market conditions.
Trades should be aware that exponential moving averages have certain disadvantages, even if they may be helpful for technical analysis. We’ll go over a few typical restrictions on trading EMA.
- The EMAs rely on historical pricing data. As a result, they can only provide a historical viewpoint and cannot forecast where prices will end up. Because of this “lagging” characteristic, EMA crossover-based entrances and exits will always lag somewhat.
- The fact that EMAs can oscillate quickly in erratic markets is another problem. If we’re not watchful, all those false crossings might result in disastrous transactions.
- EMAs also respond swiftly to even small changes in price. Hence, excessive sensitivity to minute fluctuations creates more noise than signals in slower markets without clear patterns. The tool performs best when trading momentum-driven, high-volume instruments.
- Keep in mind that EMAs are not foolproof. Before making a move, smart traders integrate EMA research with additional indicators and confirmations to accurately evaluate signals.
- EMA trading strategy cannot be identified when the crypto market is bullish.
EMA trading and SMA trading do have a slight variation. To help you understand better, we have elaborated on the difference between trading EMA and SMA below-
Factor | Exponential Moving Averages (EMAs) | Simple Moving Averages (SMAs) |
Responsiveness to Recent Price Changes | It is more sensitive to current price swings because it pays greater weight to recent price data. | Less responsive because each data point in the time has equal weight. |
Curve | Quicker moving average and a smoother curve. | Choppy and more likely to produce whipsaws |
Calculation | Emphasizes recent closing prices in the calculation by using a smoothing factor. | Finds the average by adding together all of the time period’s closing prices and dividing by the total number of periods. |
Trading Suitability | Better suited for assets with erratic momentum and choppier markets. | Functions best with diverse, non-volatile assets |
Trading Signals Clarity | Enhances the possibility of incorrect signals but can potentially produce early trading indications. | Signals might be somewhat delayed but are usually clearer. |
Common Time Periods Used | EMAs of shorter durations, such as 10 or 20 days, are frequently used. | More extended intervals, such as 50- and 100-day SMA, are often used. |
Combination Strategies | The EMA crossover approach frequently combines EMAs with varying periods, such as 5-day and 20-day. | Longer period SMA (such as 50-day and 200-day SMA) may be added to the SMA technique as a trend filter. |
SMA is focused on the trader’s price movements for a set number of days. Due to this, EMA is focused on recent price movements and hence is subject to quicker price changes.
Unlike trading SMA, trading EMA doesn’t require traders to constantly observe the closing prices for a certain number of days. For example, if you want to observe the closing prices for 50 days using EMA, the SMA can be obtained on the 50th day.
You can calculate the first EMA by considering the previous day as SMA.
This means that if N= 51st day, that is the value for your EMA.
The most analysed types of short-term averages namely:
- the 12-day EMA; and,
- the 26-day EMA.
Using the 12-day and the 26-day EMAs, one can obtain more advanced EMA techniques like ‘Moving Average Convergence Divergence (MACD)’ and ‘Percentage Price Oscillator (PPO).’
These short-term averages react aggressively, making them sensitive to market fluctuations. Some advantages of short-term averages include identifying trends and quick changes to alter entry and exit points. This technique is also useful in strategies like scalping.
Moving onto long-term averages, they typically range from 50-day EMA to 200-day EMA. Long-term averages tend to focus on the market’s overall trend rather than reacting quickly to price changes.
One advantage of long-term averages is that they Indicate longer-term patterns, thereby providing smoother support and resistance levels.
Keep in mind that the “time-frame” labels mentioned here are subjective based on your trading timeframe.
How To Use EMA In Trading
Seasoned traders who use EMA strategies understand identifying possible support/resistance zones and signals well. Growing EMAs frequently function as support, luring investors and driving the price upward.
On the other hand, Descending EMAs serve as resistance, drawing sellers and preventing rising prices.
In this section, we will cover two types of EMA strategies, i.e., Trading EMA Support and Resistance Levels and Trading EMA Crossovers.
1. Trading EMA Support And Resistance Levels
The trading EMA support level refers to when the cryptocurrency’s price is below the EMA. Investors tend to emerge and keep prices above average. It’s the opposite of trading the EMA resistance level.
Resistance refers to when the cryptocurrency price is trading above the EMA and the market is tending to a bullish trend.
Let’s take the above example of Bitcoin USDT price for the past few years. The 200-day EMA offers clear entry and exit signals for medium to long-term BTC/USDT traders. Green circles show a long position in the market, and red circles indicate a short position.
Trading EMA Crossovers
Exponential moving average (EMA) crossings are a popular cryptocurrency trading tool for detecting shifts in price momentum. EMA crossovers are useful indications for traders to consider entering or exiting a trade. It is also useful for traders to complement other tactics and analytical methods.
- Traders use two moving average lines (EMAs) with varying periods, such as the 50-day and 200-day moving averages, as a starting point.
- A “Golden cross” signal is generated when the 200-day EMA crosses below the more rapid 50-day EMA. This implies that prices may rise further and that positive momentum is developing.
- In contrast, a “death cross” happens when the 50-day EMA falls below the 200-day EMA. This signals the start of bearish momentum and the possibility of price drops.
- When a golden cross appears, the likelihood of bullish trades succeeding is higher. The trader could add to their long holdings or benefit from their current short positions.
- Using crossover signals helps traders increase profits by enhancing trade entry and exit timing based on momentum fluctuations.
- Let’s consider the below Ethereum USDT chart. The 50-day and 200-day EMA gave four medium to long-term trading opportunities, two long and one short. The second green circle signifies a support level rather than a crossing. Usually referred to as a “bear trap,” this leaves short traders unhappy after luring them in.
Advanced EMA Techniques
EMAs, or exponential moving averages, are versatile tools with a variety of strategic applications. While fundamental trend analysis may be effectively achieved with EMA tactics like crossings, some traders have created tactical applications to take advantage of market changes.
We shall dive into some of the advanced EMA techniques you can incorporate into your trading strategy.
1. Dual EMA
Dual EMA is popularly known as DEMA. It is common for traders to mix a longer EMA that catches broader trends with a shorter-term EMA that is more responsive to current price changes. The 5/20, 10/50, and 20/100 dual EMA combinations are popular.
Buying and selling might occur when the shorter moving average crosses above or below the longer one. Compared to using only one EMA, this yields stronger indications. The DEMA method involves two variables: the number of periods for the short-term and long-term exponential moving averages, subject to change to suit trading strategies.
DEMA produces a more accurate depiction of price changes by utilizing a weighted average of the two exponential moving averages to create its smoothing effect.
The Formula to calculate DEMA is-
DEMA=2×EMA(N) − EMA of EMA(N)
where:
N=Look-back period
The advantages include-
- Compared to more conventional methods, DEMA has a distinct capacity to produce signals for buying and selling that are easier to understand, helping traders gauge entry and exit possibilities.
- DEMA can spot price trends more quickly than other methods since it calculates the difference between two EMAs, allowing rapid response when markets move.
- The indicator serves as a useful tool for forecasting future market moves as it considers both short- and long-term trends.
The limitations include-
- As prices move above and below the current EMA, there might be a large lag as two EMAs cross. Traders should be aware that no trading method is error-free when considering the pace at which profits are achieved. Hence, this might lead to missing parts of an upswing or fall.
- False signals can appear in unclear positions.
2. Triple EMA
The dual crossover method is improved by including a third “signal” EMA line or TEMA. The signal line distinguishes between genuine momentum swings and false breakouts. One way to add a 50-EMA for confirmation is to use a 5/20 EMA combination.
Traders evaluate entry and exit points by looking at how all three lines interact.
The TEMA computes the single EMA (1), the original EMA’s EMA (2), and the EMA (2)’s EMA (3).
Hence, a moving average responds swiftly to price fluctuations while decreasing noise and delivering a more consistent picture of the underlying trend.
The formula to calculate TEMA:
(3∗EMA1) − (3∗EMA2) + EMA3,
Where-
EMA1: The initial exponential moving average
EMA2: EMA of EMA1
EMA3: EMA of EMA2
The advantages include-
- Traders can ignore the noise by concentrating on the direction of the 50-day moving average relative to the 200-day moving average.
- Crossovers between the slower and faster moving averages may indicate good buying or selling opportunities. Stronger rising momentum is often indicated if the fast line passes over the medium line.
- Traders may use TEMA on one-hour, four-hour, and even daily charts to seek trade signals across periods. This helps traders better timing entry and exits by switching to shorter intervals.
The limitations include-
- Due to frequent crosses without persistent price movements, TEMA may offer little information and produce incorrect signals during choppy or range-bound times.
- Given that TEMA may be readily shaken out of position, it could not be useful for long-term trading.
3. MACD
MACD stands for moving average convergence/divergenace. It is an indicator that attempts to enhance the moving average by evaluating the relative pace of price movement.
If a trader wants to know if a price trend is strengthening or weakening, using MACD might be helpful. To calculate MACD, subtract the 26-period EMA from the 12-period EMA.
How To Use EMAs In Trading Effectively
Understanding EMA trading strategies can help you book profits, considering the signals and market conditions. To trade effectively using the EMA strategy, it is essential to use more than two indicators.
EMA forecasts are based on historical price movements rather than future ones, so don’t depend entirely on them. Here are a few factors to consider to trade EMAs effectively.
The Crucial Need For Backtesting
Backtesting provides valuable information for potential trades by enabling you to assess how EMAs would react in historical circumstances. Keep in mind not to use EMAs recklessly.
Try multiple combinations and intervals with historical data to see what works best for your asset of choice and trading approach.
EMA Is Not The Whole Story
Combine EMAs with other technical indicators, such as MACD or Bollinger Bands, to gain a greater grasp of market trends and possible support and resistance zones. Remember that no single indicator can guarantee success.
Finding changes in a signal’s pattern and overbought/oversold conditions can be facilitated by utilizing numerous EMAs.
Stop-Loss Is A No-Brainer For Risk Management
Avoid being swayed away by trading signals. Stop-loss orders should be tactically set to protect your funds and reduce possible losses. Ensure you modify the exit point you set for stop losses as the trade price gradually develops.
Stay Updated With Recent Events
It is essential always to stay updated on the latest news to know about the health of your investments and portfolio. This can help you make informed trade choices that complement technical analysis.
Keep A Watchful Eye On The Price Movements
While longer EMAs smooth out volatility, shorter EMAs respond to price movements more quickly. Make a decision depending on the trading timeframe and desired sensitivity. Furthermore, EMAs may naturally trail price movement and hence miss abrupt changes.
When analysing signals, be mindful of this constraint and refrain from reacting negatively to little movements.
Mock Test Your EMA Strategies
Use mock applications/simulations to observe trend changes and test EMA trading strategies accordingly to avoid risking real capital. Ideally, you can also test the same on a paper trading environment. You can trade with real funds once you gain confidence and a clear understanding of EMA strategies.
Conclusion
EMAs are a highly effective tool that can be used with crypto trading strategies. It is also important for the trader to experiment with different EMAs, considering various timeframes. This can help the trader to identify and refine their entry and exit points accordingly.
Crypto investors may tailor indicators to their preferred risk tolerance and market viewpoints owing to the adaptability of EMAs. In general, traders participating in volatile cryptocurrency markets may see improved trading results by carefully using EMAs.
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