Building your confidence with the fundamentals of technical analysis doesn’t have to mean spending hours and hours trying to digest an online course. Sometimes, what you really need is a quick introduction to the key points so that you can have something to start thinking about. In this quick guide, we’re going to do exactly that by introducing you to the fascinating and powerful world of the Exponential Moving Average (EMA).
Improving your understanding of the EMA and seeing how it works allows you to start building more complex trading strategies, especially if you want to be able to accurately react to sudden price changes. Let’s start with the basics and build your understanding from there.
What is the EMA?
The EMA is a measure of the average value of a price across time but with the most recent values weighted more heavily than those that happened earlier. This is different from a standard moving average, where all points within a given timeframe are treated equally. You may think that a simple average that is recorded across time is enough, but this fails to take into account the dynamic nature of the market.
Prices move up and down – seemingly with a mind of their own, to the novice trader — so a simple average will not provide enough information. For example, if a price has been relatively stable for nine of the first 10 minutes, but then spikes in the last minute, this is significant. A second asset whose price gradually ticked up across 10 minutes may show the same simple moving average as the first asset, but the EMA would be different. Something significant has happened to the first asset to cause its price to spike, and only the EMA captures this information.
Breaking down the jargon
Before we go further, we need to break down a few pieces of jargon that may be confusing you. Because no guide that discusses the true EMA meaning would be complete without at least a passing mention of volatility, we’ll start there:
- Volatility: This is when the price of an asset that you want to trade acts in a way that is highly unpredictable. Picture a line that appears to be constantly changing direction and gradient, and you will be visualizing a volatile market. Traders need to be able to react to changes very quickly and trade a large number of times during the trading day when the market is volatile
- Trend: A trend is another word for what the market is doing over time. Uptrends are when prices are increasing; downtrends are when prices are falling. Traders need to understand the direction and the size of the trend to be successful
- Bearish: A market that shows a downtrend and pushes prices down is bearish. Bear markets have a lack of buyers wanting to invest and an oversupply. This can sometimes be due to a loss of confidence on the part of the traders and investors
- Bullish: A market is bullish when it exhibits a strong uptrend that is driving price increases. Bull markets are marked by high volumes of trades and increased confidence, but they can result in bubbles that eventually burst. When this happens, a strong bear market quickly emerges as everyone tries to sell at the same time
- Momentum: This is a measure of where the market is likely to go in the near future. You can think about it as the market building up to make a significant change, and its subsequent ability to maintain the new trend. For example, a bullish market with prices that are increasing faster and faster has a lot of momentum
Putting the jargon in its place like this can be really helpful when you want to focus on what really matters: applying your knowledge and improving your understanding.
Start applying the EMA
There are a variety of intuitive platforms, such as ThinkMarkets, that will show you key EMA data with the click of a button. Because you will be able to start to dive into the details at your own pace, these platforms allow you to get up to speed before you know it. Many of them also have built-in tutorials and practice options so that you can start putting what you have just learned into practice. This type of proactive approach to learning is the same one that is used by the world’s elite traders — they learn by applying their knowledge to real-world data.
Practical EMA examples
Connecting the EMA with real-world trading and investing scenarios can help you understand why it is such an important tool for traders of all abilities:
- You can use an EMA strategy when looking at ETFs, especially when you want to figure out the best time to take a new position when the market is volatile
- Using an EMA to trade stocks can help you identify sudden changes in momentum and find the right time to buy or sell
- Many traders rely on EMAs when trading forex pairs because they can get more information on the very latest market behavior than if they used a standard moving average
Using the EMA as part of a broader trading strategy is a clever approach for any aspiring trader who wants to start getting familiar with the fundamentals. It builds on your initial knowledge of standard moving averages and shows you the insights you can glean from market data when you consider different timeframes.
Conclusion
Understanding that the EMA shows you how the most recent price changes are likely to impact the next points on the chart is important. The EMA, while highly accurate, will never be 100% accurate. Less than 100% accuracy is something that every trading strategy, indicator, and metric will have in common throughout the course of your trading journey. Understanding that this is the case early on in your learning will show you that it’s more important to have flexibility as a trader and an understanding of data than it is to risk everything on a ‘perfect’ strategy.
Comments