Investors often use technical analysis to predict future directional moves.
One of the best ways to analyze the market is EMA (Exponential Moving Average).
The oldest form of analysis, EMA is largely used as an effective trading indicator.
Thousands of forex traders use this moving average indicator to draw profits in different markets.
Today, we study what is the exponential moving average, how you can use the EMA trading strategy and how you can calculate the moving average slope.
EMA Trading Strategy – Best Moving Average Setup
The EMA trading system is a universal trading strategy that works across markets including Forex, indices, stocks, currencies and crypto-currencies.
The setup also works for any time frame. This means you can trade using this strategy on your preferred chart.
Traders prefer using the exponential moving average over simple moving average because it places no weight on the recent price action.
When EMA is calculated, we don’t use a consistent multiplier and the value depends much on the recent price moves.
This is why this indicator reacts faster to the moment of price and gives a more reliable trend representation.
The EMA is aimed at minimizing the noise in the price action.
It also shows you the trend and smoothens the price factor.
It can sometimes show patterns you are otherwise not able to see.
This average is also an accurate way to forecast future changes in the price.
There are two elements involved in the execution of the EMA trading strategy.
You capture a new trend by using two EMAs as an entry filter.
The strategy is automated by using one moving average with a shorter and the other with a longer period.
This would eliminate any form of subjectivity from the strategy.
The first step is to set up the charts with the right exponential moving averages. The strategy involves the use of 20 and 50 periods average. Most trading platforms have default indicators for moving averages and your EMA can be easily located on the chart.
A rule of this strategy is to wait for the price to trade over the two EMAs. We also need to wait for the EMA crossover for the buy trade till the lower average crosses above the higher one. We can automate the buy and sell signals.
A good idea is to test the zone two times before finding any buy opportunities. Two successful retests between the two EMAs will give enough time to the market to develop a trend. The aim is to cover the price spectrum between the two.
When you retest the price successfully in the zone between the two EMAs for the third time, you can proceed to buy at the market price. This is because you know that the momentum is strong and the market will go higher.
Once you have the EMA crossover and two consequent tests, you can determine a trend. The trend would remain intact if you are trading above the EMAs. So you place the stop loss below the 50 EMA. You can place it 20 pips below this EMA as the market can have false breakouts.
The exit technique is not based on the EMA crossover for this setup. You should understand that EMAs are lagging indicators. This indicator would allow taking profits at the time when the market starts reversing. So take the profit when you break and close below the 50 moving average.
Moving Average Slope Strategy
A bullish convergence is generated by the price above rising averages, supporting strategies with longer hold positions.
Such an alignment is common in bull markets and uptrends.
On the other hand, the price below rising averages creates a bullish divergence favouring value plays and dip-buying opportunities.
When the price is traded above averages whose slopes oppose, it conflicts and indicates a long-side play while a falling slope denotes a high-risk condition.
Similarly, when the price falls below the moving average, it is a bearish convergence adding to short sale strategies and encouraging long-holding positions.
Such an alignment can be seen in downtrends.
Price above falling moving averages creates a bearish divergence favouring short selling and profit-taking.
Trading below averages with opposing slopes indicate conflict, supporting short side plays while a rising slope is an indication of the impending bottom.
The interrelationship between moving average, slope and price is quite complex.
Conflicts should be used as indications as these interweaving structures are significant factors for short and long term trading opportunities.
You should also look for convergence and horizontal orientation of the moving averages to keep track of noise levels that denote weak opportunities.
Moving Average Shift Strategy
Moving average shift strategy works on the basis of the slope relativity.
Long-term moving averages change slope less frequently as compared to short-term averages.
A 20-day moving average oscillates between falling and rising slopes numerous times over a period of 3 months while a 50-day average would shift only 2-3 times.
On the other hand, a 200-day average may not shift at all or do it only once in a time.
This type of relativity can be seen in the chart in two ways.
Firstly, a long-term moving average puts greater resistance or support than a short-term average.
Secondly, falling and rising slopes add or subtract from the resistance or support depending on the position of the price in relation to the averages.
A moving average shift strategy is a great way to adjust a normal average to fit the trendline.
In this type of structure, a rising long-term moving average has higher support as compared to a falling average when the price trades above the level.
A falling average, on the other hand, has higher resistance than a rising average when the price trades below the level.
How To Calculate Moving Average Slope?
A popular technical indicator, the moving average slope provides useful information about the market trend.
To use any automated trading system, you need to calculate the moving average slope.
Calculating the slope of a moving average is quite simple.
You just need to compare the last moving average with the present.
However, you should use a higher number of bars for the calculation to minimize noise and false signals.
You can also add another indicator like ADX or add another moving average slope indicator.
This indicator can be used to create various moving average slope trading systems.
The key premise of the exponential moving average is the weightage placed on the most recent data points.
Like most moving averages, EMAs are most suitable for markets that are trending, but unlike others, it helps identify trends based on the most recent activity.
Exponential moving averages are powerful tools for traders.
However, they can result in false alarms for beginners who are yet to get familiar with a particular security.
Trading forex on margin carries a high level of risk and may not be suitable for all investors. You may lose all your capital. Losses can exceed deposits.
Past performance is not indicative of future results. The performance quoted maybe before charges which will have the effect of reducing illustrated performance.
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