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The exponential moving average (EMA) is one of the most commonly utilized forex trading tools. Traders use the EMA overlay on their trading charts to determine entry and exit points of a trade based on where the price action sits on the EMA. If it is high, the trader may consider a sale or short sale, and conversely if it is low, a buy.
Key Takeaways
- The EMA can be a useful forex trading tool when considering entry and exit points and is one of the most popular trading indicators.
- Using the EMA should be used in conjunction with other trading tools, most commonly MACD, RSI, and others.
- Forex trades will often encounter some form of resistance or support when encountering long-term EMA crossover points, and see a significant increase in volume.
The EMA differs from a simple moving average (SMA) in two primary ways: more weight is given to the most recent data and the EMA reacts faster to recent price changes than the SMA.
The EMA is very popular in forex trading, so much that it is often the basis of a trading strategy. A common forex trading strategy that uses EMAs relies on selecting a shorter-term EMA and a longer-term EMA and then trade based on the position of the short-term EMA in relation to the long-term EMA.
A trader would then enter buy orders when the short-term EMA crosses above the long-term EMA or enter a sell order when the short-term EMA crosses below the long-term EMA. When discussing the numbers of EMA such as a 20 EMA or 10 EMA, this number signifies the preceding time period selected by the trader. Usually, this amount is in days, so a 20 EMA means the EMA is an average of the preceding 20 days, a 50 EMA is the preceding 50, and so on.
Using EMA Crossovers as a Buy/Sell Indicator
When considering strategy, a trader might use crossovers of the 50 EMA by the 10 or 20 EMA as trading signals. Another strategy that forex traders use involves observing a single EMA in relation to price to guide their trading decisions. As long as the price remains above the chosen EMA level, the trader remains on the buy side; if the price falls below the level of the selected EMA, the trader is a seller unless price crosses to the upside of the EMA.
The most commonly used EMAs by forex traders are the 5, 10, 12, 20, 26, 50, 100, and 200. Traders operating off of shorter timeframe charts, such as the five- or 15-minute charts, are more likely to use shorter-term EMAs, such as the 5 and 10. Traders looking at higher timeframes also tend to look at higher EMAs, such as the 20 and 50. The 50, 100, and 200 EMAs are considered especially significant for longer-term trend trading.
Using the EMA is so common because although past performance does not guarantee future results, traders can determine if a certain point in time—regardless of their specified timeframe—is an outlier when compared against the average of the timeframe.