In the context of finance, a moving average is a technical indicator that calculates the price points of an asset within a specified time frame — which in most cases, a 200-day period timeframe is used. By doing so, traders can determine the trajectory of the current trend while also reducing the chances of random price spikes to occur. Or it can identify its support and resistance levels.
The support refers to a level where the price normally stops falling and bounces back up, whereas the resistance refers to a level where the price often stops rising and falls back down. When the price reaches or exceeds a support or resistance level but quickly reverts back to its original trajectory, this is called a “test”. But if the price breaks any level for a longer time, there’s a good chance that the price will continue rising or falling until a new support or resistance level is set.
To identify the support and resistance levels, enable the Moving Average indicator. If the trendline heads upward, mark the support levels. Like so. Imagine the support level as if it’s a trampoline. Notice how the price bounces off of the line. The support level moves in accordance with the trendline’s trajectory. You’ll see that the price has started to exceed the support line and for a long time. You’ll get the idea that the asset is experiencing a downward trend. So, from here on, mark the resistance levels.
Much like the support levels, the resistance levels move in accordance with the trendline and the price does not break that mark. That is until the trend changes direction again. Nowadays, there is a huge range of moving averages available for traders to use. One of them is the Exponential Moving Average or EMA for short, which is the subject of this article.
An Exponential Moving Average — alternatively known as the exponentially weighted moving average — places more emphasis on the most recent data points and is more sensitive to recent price changes than a Simple Moving Average or SMA. In comparison, SMA applies equal weight to all data points within the period. So, an EMA may introduce signal “noise” which may give a false-positive indication.
While EMA does better in terms of sensitivity compared to SMA, it is also more likely to experience short-term changes than an SMA. So, keep that in mind. When the EMA rises and the prices fall near or directly below the EMA, it may be a good time to consider buying. Similarly in the other way around, you might want to sell when the prices rises towards or right above the EMA. All MAs — including the EMA — are not designed to spot a trade at the exact bottom and top. The EMA is often used to complement other indicators in order to confirm strong market moves.
That being said, EMA is great for traders who trade intraday and fast-paced markets. It is not uncommon for EMAs to be used to determine trading bias. An intraday trader may decide to trade only on the long side if an EMA on a daily chart displays a significant upward trend.
