A the EMA strategy — it’s one of the most basic trading strategies that chartists use to determine stock levels.
In explaining this strategy, we’re going to cover the following sections:
- What is the EMA Trading Strategy?
- The EMA Trading Strategy in action
- How Can You Use Exponential Moving Averages to Trade Stocks
- Why trade with this strategy?
- How to use the strategy for trading stocks and ETFs
- When to trade using this strategy
- When you should avoid this strategy
- What are the different types of trading strategies?
- What is an EMA Crossover strategy?
- What is a Pullback Trading Strategy?
- Which EMA is best for intraday?
- What is a simple moving average?
What is the EMA Trading Strategy?
An EMA trading strategy is a simple method of identifying trade opportunities. EMA stands for Exponential Moving Average, which is the average price of certain financial instruments over a period of time. It is a time-weighted trading system that uses the exponential average of the previous 11 prices when they are in sequence.
This EMA trading strategy is used to identify areas where price should change direction.
Some traders try to use it with buy decisions when their price spikes upwards before reaching their two week EMA.
Others wait until there’s a 12% or more sell off before buying in. If you buy after volatility drops below 10%, it would make an excellent short term trade at any point prior to reaching your five week EMA.
The EMA Trading Strategy in action
Traders use the exponential moving average (EMA) to determine when shares are trending. For example, if prices are above the EMA then traders will buy in anticipation of an upward trend in stock prices. Similarly, if prices are below the EMA traders would indicate their intention to sell in anticipation of a downward trend in stocks. The opposite is true when trading with short-term moving averages like SMA’s which follow the same general principle but only use limited data points.
How Can You Use Exponential Moving Averages to Trade Stocks
Explanation of how an exponential moving average can be used to trade stocks
We start by looking at a company’s daily share price. For example, if the stock price is 285, then the equivalent share price at day -1 would be 286 and at day 2 it would be 272. So we calculate the average by combining them and get 282. From there we use this number to predict what will happen with our stocks in the future.
EMA stands for exponential moving average. It is calculated by calculating an exponentially weighted average of the given time period’s worth of data. The weightings are calculated so that more recent prices are proportionately more important than earlier prices, with the most recent price having the largest effect. EMA is used as a smoothing technique to remove day-to-day volatility, without radically distorting how much one day’s price influences another or previous days’ prices.
An exponential moving average places more weight on recent prices in comparison to an ordinary moving average. An EMA provides a smoother line of reflection for the data, but it does so at the expense of looking ahead to predict future market volatility, or lack thereof. When it comes to investing in stocks, exponential moving averages are preferable because they are sensitive enough to fluctuations so market equilibrium is predicted accurately before fluctuation occurs.
Why trade with this strategy?
One reason you might want to use EMA is that it gives you a way of entering the market by triggering on averages, not individual points. It also smooths out “noise” in the larger cycles or trends.
Buying at the lows and selling at the highs–that sounds so easy, but it can be very difficult for an individual investor. Every decision might seem right until guess what happens…you were wrong! Average-based systems are less susceptible to this problem because they enter near high or low unless conditions change dramatically during the trade cycle which will then produce a new set of buy and sell signals.
How to use the strategy for trading stocks and ETFs
The EMA is a trend following system, and it will work nicely if you are looking to make profitable trades in general. Essentially this strategy buys when the EMA goes down from the previous day’s high and sells when the EMA goes up from the previous day’s low point.
When to trade using this strategy
You use EMA for stocks when they are in the accumulation phase.
The EMA is most accurate when used on trends, not levels. When two (or more) EMAs of varying lengths intersect that there is very little variation between the heights of the tops and bottoms then that means that trend has paused or stopped.
The reason to use EMAs on stock trends is because it’s easy to recognize trends, whereas price levels can vary significantly depending on how wide (and low) bid offers are relative to ask offers as well as time of day and other factors. In technical analysis terms the technique known as “triangle retracement” can be applied using EMAs too, which works best for those who have a longer term EMA (in this case 50 EMA) to look for the mid-term trend (in this case EMA 20), and then plot EMA 10 on top of EMA 50.
When EMA 10 goes directly through EMA 20 that means the mid-term trend is continuing, but if there’s a break down or a break up EMA 10 and EMA 50 it means that EMA 20 is now the mid-term trend.
When you should avoid this strategy
This EMA technique will break down when there is a lot of noise in the market. Noise is created by:
– low volumes (there’s not enough activity to spread out and create a consistent trend)
– EMA length (some EMA lengths work better than others–see the section below regarding EMA Lengths for more information)
– EMA intervals that are too short or too long.
Market noise can be influenced by a number of factors. For instance, the media may have an effect on stocks because it’s their job to get people interested in what they are selling, so they sometimes give more coverage to stocks the lose money than the ones that do well. Social media may also increase noise in the market because people can let their opinions be known quickly and easily online through their networks. Political changes or anything else that comments on a specific company or product can have an affect too if it leads to a biased perspective that leads investors to buy/sell stock based only on rumor alone.
What are the different types of trading strategies?
There are four primary types of stock trading strategies.
The buy and hold strategy is a passive holding strategy which involves buying stocks and holding them for the long term to build wealth. This tactic does not affect portfolio turnover, so it’s best for investors who don’t want to be involved in the decisions on when they sell their stocks.
The momentum investing strategy tries to take advantage of short-term market changes by focusing on making money rather than trying for capital gains, with an inside approach that will relieve you from conducting research.
Day trading takes place during one business day, up until about 20 minutes before close, where trades are performed electronically through margin buying or selling securities which is done without owning those securities . This strategy is very active and trades are conducted within a short time frame.
Swing trading is when you place a trade and hold it longer than 1 trading day. It is the most common type of active trading and is a great alternative to trading all day.
What is an EMA Crossover strategy?
A crossover strategy is a stock trading strategy in which an investor subscribes to two or more contradictory or competing indicators and then invest when one of the indicators change its signal. This type of strategy relies on identifying incorrect information and timing and exploiting it by buying and selling stocks.
EMA Crossovers involve stocks that belong to the same industry group but have different capitalization, such as small-cap versus large-cap stocks. These strategies can potentially earn higher reward than traditional crossovers, because investors will accumulate both large-cap growth stocks with high potential returns but also mid cap opportunities at diversified price levels for downside risk control.
What is a Pullback Trading Strategy?
A pullback trading strategy typically involves looking for stocks to sell on a rebound, and buy after they have dropped in value. This is seen as a way to take advantage of dips in the market when buying shares in stocks at much lower prices than their historical average, with the idea being that after time passes and people forget how much that stock has been falling, it will recover its price from then -but if it doesn’t pullback even more-, then you would have been better off just waiting.
Apart from simple pattern recognition techniques such as “candlesticks,” this strategy requires knowing an individual stock’s volatility so one can appropriately identify what constitutes a “significant” change or significant downtrend before stepping in.
Which EMA is best for intraday?
The best EMA for stocks is the Volume-Lagged Average, or volume-lagged MA.
The main way it differs from other EMAs is because of its extra lag time; instead of calculating the average over a short term period, like most conventional averages (e.g., 10 days or 20 days), this moving average acts as an accumulation to reflect long term trends in volume like bottoming out at times of poor market sentiment and spiking up during periods when sentiment increases significantly.
Since it’s lagging by 350% the current trading day’s volume (or 730% if you’re using monthly data), then any major spike in volume will be less dramatic than the move would’ve been without lag.
What is a simple moving average?
A simple moving average (SMA) is an unweighted arithmetic mean, based on the average of values in a set of time periods. Basically, when you calculate the SMA for a set of points, you scale all points equally by adding the two endpoints together and dividing by two.
So in this case, a simple moving average is the sum of the past n stock prices divided by n.
If you’re just getting started trading, we recommend that you read “Bullish Charting — Profiting From Simple Positive Stock Setups” by Samuel Goldman.