Exponential Moving Average
The Exponential Moving Average (EMA) is a trending indicator that is a variation of the Simple Moving Average. The EMA indicator is a moving average for time-series data which places greater weight on more recent data. Used to smooth and eliminate volatility of short term (daily) price movements, the EMA is plotted on top of the price movement of a stock, and assigns more importance to the most recent prices.
Considered a lagging (or reactive) indicator, EMA reduces the lag by applying more weight to recent prices relative to older prices allowing the EMA to react faster to recent price changes than the Simple Moving Average. That is, considering a 10-day price chart for a given stock, the prices on the ninth and tenth days will be weighted more heavily as components of the average.
EMA is used by traders to identify trend direction, support and resistance levels, and also to generate buy and sell trading signals. The two commonly used EMAs are the 50-day and 200-day. The 200-day moving average is used to measure the long-term trend, while the 50-day moving average picks out intermediate trends. The EMA slope is always down when price closes below the moving average. EMA slope is always up when price closes above the moving average.
Basic EMA: Price Crossovers
The most typical setup when using the Exponential Moving Average to generate trading signals is called a Price Crossover. When using the Price Crossover method for signals, a trader uses two EMA of different period lengths (ie: a 50-day EMA and a 200-day EMA). The longer term EMA confirms the long term trend while the price crossover with the shorter term EMA generates trading signals.
- Trading Signals
Bullish Buy Price Crossover – Price crosses above the 50 EMA while the 50 EMA is above the 200 EMA.
Bearish Sell Price Crossover – Price crosses below the 50 EMA while the 50 EMA is below the 200 EMA.
Advanced EMA: Divergences using Twiggs Money Flow
The Exponential Moving Average also forms the basis for many other technical indicators and overlays, such as Bollinger Bands, MACD, McClellan Oscillator and Twiggs Money Flow.
Twiggs Money Flow (TMF) is a price/volume oscillator that is used to warn of price breakouts and provides trend confirmation. Using True Range (high/low daily range plus any gap from the closing price of the preceding day) and a suggested 21-day Exponential Moving Average (EMA), TMF utilizes volume to quantify the amount of money flowing in or out of a stock and assumes that in a bull market prices will close in the upper half of the range and that the reverse is true in a bear market.
Plotted on a sub-chart below the main price chart and oscillating above and below a zero line, TMF indicates accumulation if above zero, while negative values indicate distribution. The higher the readings above (or below) zero, the stronger the bullish (or bearish) trend. Trading signals are generated with bullish (positive) and bearish (negative) divergence between TMF and price.
Divergence (either positive or negative), is used to signal a major shifts in the direction of price as well as generating trading signals. Positive divergence occurs when the price makes a new low while the indicator starts to climb upward. Negative divergence occurs when price makes a new high, but the indicator fails to do the same and instead closes lower than the previous high. Binary traders can interpret this as a high probability call signal.
A bullish divergence occurs when prices fall to new lows while the oscillator fails to reach a new low indicating weakness in the downtrend. While a bearish divergence occurs when prices rally to new highs while the oscillator refuses to reach a new peak signalling a reversal in the uptrend. Binary traders can interpret this as a high probability put signal.
Bullish Buy – When there is a bullish divergence between the Twiggs Money Flow and price.
Bearish Sell – When there is bearish divergence between the Twiggs Money Flow and price.
Responsible money management ensures that the losses don’t mitigate the profits.