Exponential Moving Average (EMA)
The exponential moving average is another type of moving average that’s similar to the simple moving average, which measures the trend and direction of an asset over a specified period.
How the EMA indicator works
You should apply similar rules when using the simple moving average. However, you should keep in mind that the exponential moving average has a slightly higher sensitivity to price changes compared to the SMA. The high sensitivity is advantageous in that it makes it possible to identify a trend quicker compared to the SMA, but on the other hand, it experiences more short-term changes compared to a similar simple moving average.
When using the Exponential Moving Average to determine the trend direction, you should always trade in the direction of the trend. Generally, buy when the prices drop or are near the EMA and when the EMA is rising. When you have a falling EMA, you should sell when the asset price is moving above the Exponential Moving Average.
It is essential to the point that you can use the EMA to find the resistance and support levels. A rising exponential moving average is associated with the support level if the price of the asset is above the EMA and a dropping exponential moving average provides resistance for the asset if the price is below the exponential moving average.
You should understand that both the simple moving average and the exponential moving average are not designed to show a trade at lows and highs. The moving averages indicate the trend direction where you can trade towards but will delay confirming the entry and exit points.
Most traders view the exponential moving average as superior to the simple moving average. This is because the EMA weighs more on current data compared to past data.
However, you should weigh between the advantages and disadvantages of the exponential moving average before you decide to use it.
EMA vs. SMA
- The exponential moving average and the simple moving average have one thing in common; they both measure trends.
- Another similarity between the two is that they follow the same principles and are both used to smooth price fluctuations in a trade.
- The primary difference between the simple moving average and the exponential moving average is based on their sensitivity to data used in their calculation. The exponential moving average weighs more on current data of a trading period while the simple moving average calculates the average of the entire period.
This difference makes the EMA more accurate compared to the SMA when determining price action. In cryptocurrency trade, it is more important to have a grasp of what’s happening currently rather than what happened in the past.
Just like the simple moving average, the exponential moving average has the lagging drawback because it also relies on some historical data.
It is essential to point out that the moving averages only smooth data in the trading market to create a trend indicator. Moving averages cannot predict trend directions; they only define the current trend direction. The exponential moving indicator and the simple moving indicator form the basis of other technical indicators like the Moving Average Convergence Divergence and the Bollinger bands.