- Forex Basics
- Japanese Candlesticks
- What Are Japanese Candlesticks?
- Bodies, Wicks and Shadows
- The Doji Candlestick Pattern
- Candlestick Engulfing Pattern
- Hammers and Hanging Man
- Piercing Pattern and Dark Cloud
- Morning Star and Evening Star
- Harami Patterns
- Shooting Star and Inverted Hammer
- The Kicker Signal
- Three White Soldiers and Three Black Crows
- Three Inside Up and Three Inside Down
- Three Outside Up and Three Outside Down
- Concealing Baby Swallow
- Upside Gap Two Crows
- Advance Block
- Three Stars In The South
- Two Crows
- Unique Three River Bottom
- Moving Averages
- Elliott Wave Theory
- Oscillators/Indicators
What is an Exponential Moving Average?
The simple moving average is extremely popular but like all technical indicators it does have its downside. Because each data point is weighted the same as every other data point, some traders think the SMA is limited because they believe that more recent data is more significant that the older data. For example, if the last 200 days were in an uptrend, but the last 20 days of that is in a down trend, wouldn't the last 20 days be more important that the 180 prior to that?
This concept lead traders to giving more weight to more recent data, and because of this new moving average types have been created. Lets learn about the most popular weighted moving average: The Exponential Moving Average and EMA indicator technical analysis.
Exponential Moving Average
The exponential moving average gives more weight to more recent prices in an attempt to make it more responsive to current information.
Exponential moving average is calculated by adding the moving average of a certain share of the current closing price to the previous value. With exponential moving averages, the latest prices are of more weight. P-percent exponential moving average will look like:
EMA = (CLOSE(i)*P)+(EMA(i-1)*(100-P))
Where:
CLOSE(i) — the price of the current period closure;
EMA(i-1) — Exponential Moving Average of the previous period closure;
P — the percentage of using the price value.
Since there is no previous EMA value for the first point, take the previous day's SMA instead. Then move on through each following day using the EMA formula.
Nearly all charting packages will do EMA calculations for you simply by entering in your desired parameters into the indicator.
The Difference Between the EMA and SMA
As you can see in the EMA equation, more significance is placed on the more recent data points giving the more recent days more weight.
Lets see how this looks on a graph:
We have graphed both SMA and EMA based on a 10 day period. The day at point 1 is a big down day. Actually, it is the start of a bearish reversal. If you look at the SMA vs. the EMA, you can see that the EMA turns fairly quick showing the downtrend much sooner than the SMA. Thats because the EMA puts more weight on the more recent days, showing the reversal faster. The SMA takes longer to react, and only starts is downtrend indication after the marke has already had several down days.
The day at point 2 is showing a drastic up swing. It goes up for a few days, and you can see the EMA turns to indicate the uptrend, while the SMA is only slightly affected by it.
Notice how the EMA shows the trend changes between points 2 and 3 where the SMA barely even recognizes them. Finally at point 4, a long uptrend starts and eventually the SMA and EMA once again agree on the trend direction. This responsiveness to the market trend is the main reason why many traders prefer the Exponential Moving Average.
When creating a moving average of any type, you can use any time period that works with your trading method. The shorter the period you use, the more volitile the average will be, showing changing trends faster. The longer the period you use, the more smooth the average will be.
