This is the third article in our EMA series. If you haven’t already, we suggest that you check out the first article about the EMA Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the “Exponential Moving Average”, or “EMA”, indicator. The EMA was designed to smooth out the effects of price volatility and create a clearer picture of changing price trends. Traders use an EMA, sometimes in concert with another EMA for a different period, to signal confirmation of a change in price behavior.
The benefit of the EMA indicator is its visual simplicity. Traders can quickly assess the prevailing trend of price behavior from the direction of the EMA. Care must be taken since the EMA is a lagging indicator and may not adjust rapidly to volatility in the market. An EMA works well in strong trending markets, but tends to give false and erratic signals in ranging or sideways markets. Shorter period settings can lead to false signals, too.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points that can be discerned from using EMA analysis. Using the EMA in combination with another technical indicator is also always highly recommended.
A simple trading system would then be:
- Determine your entry point at the crossover when the “Blue” EMA crosses the slower “Red” EMA in an upward fashion;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point when the “Blue” EMA crosses back through the “Red” EMA in a downward direction.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded a profitable trade of nearly 90 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, EMA technical analysis will provide you with an “edge”.
That concludes our series on the EMA Indicator. For further reading please visit our Forex indicators section.
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