Forex and cryptocurrencies are some of the most traded financial instruments, given the unique trading opportunities they give rise to daily. Day traders use various tools to analyze the market. The Exponential Moving Average (EMA) is a tool that finds great use among technical analysts and day traders.
Offered by most charting packages, the EMA is an indicator that allows traders to get insights into the direction price is moving, up or down. In addition, it is ideal for identifying entry and exit levels while trading currency pairs and cryptocurrencies that are trending.
EMA edge, as one of the most effective tools for identifying the underlying trend, stems from the fact that it pays more attention to the most recent prices. Therefore, it allows traders to understand the direction price is moving. While day trading, it is important to know what the market is doing at present rather than what happened a few weeks before.
The chart above clearly shows that the red line, the 30EMA, is much closer to the price than the blue line, which represents the 30SMA implying how responsive it is to price changes. Conversely, the 30EMA provides an accurate representation of the ongoing price action as opposed to 30SMA, which is lagging.
Below are the popular EMA trading strategies.
Single EMA strategy: trend following
The Exponential Moving Average is a powerful tool for identifying the underlying trend of a cryptocurrency or currency pair under study. The 200EMA is commonly used to identify the direction price is moving.
Whenever the price is above the 200EMA, it is considered bullish, implying that it will continue moving up, making higher highs and higher lows. With this strategy, traders look to enter long positions whenever the price pulls back to the 200EMA, which acts as a strong support level. The formation of a bullish candlestick above the indicator signals strong upward momentum acting as a signal to open a buy position.
Similarly, whenever the price crosses the 200EMA and edges lower, such that it is below the indicator, the underlying asset is considered bearish. Consequently, traders use this opportunity to enter sell positions whenever the price bounces back to the EMA, only to get rejected at the resistance level and continue moving lower.
The formation of a strong Bearish candlestick at the 200EMA affirms the strong bearish momentum implying prices are likely to continue moving lower in continuation of the downtrend. Conversely, traders will focus on short positions whenever there is a bounce-back that is rejected at the EMA, which in this case acts as the resistance level.
EMA crossover strategy: bullish breakout
The crossover strategy entails using two EMAs, one that is fast-moving and the other one that is slow-moving. For instance, day traders use the 50EMA as the fast-moving and 200EMA as the slow-moving as part of the crossover strategy.
A bullish breakout would come into play whenever the 50EMA crosses the 200EMA from below and starts moving up. Such a crossover implies the start of an uptrend, affirming a build-up in buying pressure. Conversely, a trader would look to enter a long position once the crossover happens.
It would be wise to wait for further confirmation instead of entering a long position as soon as the crossover happens. Once the price moves above the 50EMA upon the crossover, one can wait for a pullback to the 50EMA. If the price fails to close below the 50EMA, it will imply strong upward momentum. Consequently, now would be the best time to enter a long position.
As long as the price holds above the 50EMA, which acts as a support level, a trader can look to open buy positions as the prospect of price edging higher will always be strong.
EMA crossover strategy: bearish breakout
The bearish crossover strategy is signaled whenever the fast-moving 20EMA crosses the 50EMA and starts moving lower. The crossover implies a build-up in selling pressure likely to push prices lower. Once the price is below the 20EMA on the crossover happening, it affirms short sellers are in control.
Traders can look to enter short positions as soon as the price breaks below the 20EMA and bounces back to the EMA. Should it fail to close above the EMA, it implies strong short-selling pressure. In this case, one can open short positions to form a strong bearish candlestick below the 20EMA.
As long as the price is below the 20EMA and 50EMA, traders can look to enter a short position with every bounce back that gets rejected on the two EMA, which act as resistance levels as prices move lower.
Using EMAs for exit strategies
The EMA is also a powerful tool that can be used for exit strategies to know the ideal points to close positions be it at a profit or loss. In case of a bullish breakout, traders can look to exit the market whenever the price closes below the 50EMA and 200EMA and starts moving lower.
The price must always be above the two EMAs for the bullish breakout to hold. However, it implies a build-up in selling pressure when it closes below the two indicators. A change from an uptrend to a downtrend would be affirmed by the 50EMA crossing the 200EMA and moving lower, implying the start of a downtrend. Such a formation is known to attract short sellers who push prices lower.
In case of a bearish crossover breakout, traders can look to close short positions as soon as the price moves above the 50EMA and 20EMA, implying a build-up in buying pressure and waning sell-off momentum. The 50EMA crossings the 200EMA and moving up will only affirm the change from a downtrend to an uptrend. Such a formation is known to attract bulls as bears exit the market.
The Exponential Moving Average is one of the most effective tools for identifying trends, entries, and exit points as it pays more emphasis on the most recent prices. Conversely, it tends to be one of the most effective tools for traders looking to day trade forex and cryptocurrencies.