We know that the Exponential Moving Average (EMA) is a line formed by calculating the average of a predetermined figure of period points and averaging them.
On the other hand, unlike the simple moving average, added weight is given to new data points. Equal weight on period points are given in the SMA indicator. Why is this done? This indicator was created as a moving average that reacts well to market changes.
Thus, the birth of the exponential moving average indicator. If you were to enter a 20 SMA alongside a 20 EMA, the exponential moving average will always react to price movement sooner than the SMA would. But there is a negative side to this behavior. The quick reaction can give out many false signals.
This is particularly troubling in a side trending market. In a ranging market, very nearly all forex traders avoid the use of any indicator based on the moving average.
A strategy that is quite popular with traders is the EMA crossover. Typically, traders use the 13 plus 5 EMA in this strategy. Any cross from the 5 ema above or under the 13 ema indicates a buy or sell signal. In a trending market, this strategy works quite well. If used when the markets are side trending, prepare to lose money.
A variant of this strategy is the three EMA cross over. Forex traders select the EMA of 4, 9 as well as 18. All three periods represent the short term, long term and mid term trends of a financial instrument.
A signal to buy would take place when both 4 and 9 exponential moving averages cross on top of the 18 EMA. Conversely, should both the lines cross underneath the 18, this is a signal to sell.
While this indicator does have its uses, it should always be used in conjunction with additional tools for the best probability of success. It is used to verify the trade and too much weight should not be given to it on its own.
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