What is Exponential Moving Average?
The exponential moving average (EMA) is a technical indicator that emphasizes the importance of the recent data points of a financial asset. Its essence is to pick up on the recent price changes that an asset has just made, making it more precise than a simple moving average (SMA).
The exponential moving average has different lengths. However, the commonly used lengths by traders are the 12-day, 10-day, 26-day, 50-day, and 200-day moving average.
Traders who want to analyze the short-term price movement of an asset usually opt for the 12-day and 26-day exponential moving averages. These two EMA lengths can also be used to create other technical indicators such as the moving average convergence divergence (MACD).
Lengthier exponential moving averages like the 50-day and 200-day EMAs are more suitable for the long-term analysis of an asset’s price movement.
An advantage that the EMA gives to traders who use it to ascertain a trading entry point is that it does not lag, unlike other moving averages that do this and cause traders to miss out on a good trading entry point.
How to calculate the EMA
Calculating your EMA requires you to calculate your SMA by one extra day first. To arrive at your EMA, calculate the sum of an asset’s closing price divided by the number of observations within a certain period. After this, you must calculate the multiplier for smoothing the EMA.
The formula for this is: [2 ÷ (number of observations + 1)] while the formula for calculating the present EMA is: EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier).
It is important to note that the EMA allocates a higher weight to new prices while the SMA allocates a balanced weight to all prices. The weight allocated to new prices is more suitable for a short period EMA.