EMA, or Exponential Moving Average, is a derivative of the Simple Moving Average (SMA) and is an indicator available on most charting platforms that helps traders identify trends and potential entry and exit signals. With a variety of options for strategies in trending markets, this article focuses on reviewing EMA and how it can be used to create a comprehensive trading strategy for forex trends.
A Trading Strategy Using Ema In Three Steps
The strategy outlined below involves using a series of Exponential Moving Averages (EMAs) for trading. Like the Simple Moving Average (SMA), EMAs show the average price for a given period directly on the chart. However, the EMA places greater emphasis on recent prices by assigning them more weight in the calculation, reducing the lag that is often seen with the SMA. This makes the EMA an ideal choice for trend trading.
Identify the Trend in Your Forex Pair: Step 1
Prior to entering a position based on trend, it is essential for traders to confirm the trend’s direction. The following daily chart displays the EUR/USD pair. As the pair creates higher highs and higher lows, it is currently indicating an uptrend. This analysis can be supported by the use of a 200 EMA as shown on the chart. Typically, traders are bullish when the price remains above the 200 EMA and bearish when the price falls below this average.
Trend analysis for EUR/USD:
Using EMA To Time Entries: Step 2
After confirming the uptrend, traders can use a 12-period and 26-period EMA to time their entries. When buying in an uptrend, traders should look for areas where momentum is turning back in the direction of the trend. EMA’s can help identify these areas by recognizing a crossover point where the shorter period EMA (12) crosses above the longer period EMA (26). The EUR/USD chart below displays several potential buy entries using EMA’s. It is important to note that this process can be reversed for a downtrend by selling when the 12-period EMA crosses below the 26.
EUR/USD entries:
Using Ema To Find Exit Positions: Step 3
The final step in a successful strategy is to determine when to exit the market after opening a trade. Traders can choose from various stop/limit and risk-reward combinations to meet their trading requirements. EMA’s can be used as a part of the exit strategy. Since traders buy when there is a return to bullish momentum, it makes sense to close positions when the momentum wanes. In an uptrend, traders can identify this when the price touches the 12 period EMA.
Traders should also place stops when trading with the trend. One simple approach is to place stops under a swing high or low on the chart. This way, if the trend changes, positions can be exited quickly to minimize losses. The chart below illustrates this method using part of the trade example discussed earlier.
EUR/USD exits:
A Summary of EMA Trading
In summary, EMA trading offers a complete system for trend traders to identify trends, time their entries and exits. Despite being perceived as a complex indicator, this article has shown that the EMA can be simple and effective for both beginners and experienced traders.