Greetings traders and welcome back. Thank you for joining me yet again.
Chris here, bringing you another Survival Guide.
Today's discussion will be based around the exponential moving average.
It's a slightly more complicated version of the simple moving
average, but all in all, it is still extremely easy to use and understand.
If you are a new trader, this is definitely going to be
something that should be friendly for you, especially if you're
talking about passing that Gauntlet Mini with your friends.
Without further ado, let's show you how you can apply the
exponential moving average to your chart,
otherwise known as the EMA, that way you can follow along
the entire time during today's video. In order to do so on the Finamark platform,
we're gonna go up here to the top center and click the "show
indicators options" button.
Then, we're going to scroll down to where it says "exponential moving average".
It's the second on the list at the moment. Give that a click,
and we are all set. By default,
this is a 14 period exponential moving average, and if you
want to change yours, you can do so by
coming back over here to the section 1 tab, clicking the
cogwheel, where you'll then see that you can change the color
as well as the period to whatever you so choose.
Without further ado, let's get going.
Each and every day the pool of technical indicators available
to traders grows a little deeper as more are thrown into
it. Some of the very first indicators out there are still around today,
and usually, they're still being used today for good reason.
One of these indicators is the exponential moving average.
It is one of the first to be thrown into that proverbial technical indicator pool.
What is the exponential moving average? Well, the exponential
moving average is usually referred to as an EMA
because it saves you that mouthful of words, and it's just
an advanced version of an SMA, which we know is a simple moving
average. The concept is simple. It is going to put greater
weight on the most recent data points in comparison to data
points that are farther in the past.
The idea here is to pay more attention and apply more analysis to the most
recent occurences in the market to attempt to give
us a more accurate view of what is currently happening
and what is currently about to happen.
That is the general concept. The EMA ensures that the old
and redundant data points do not have the same influence
on the indicator as the latest data point.
That's the general concept here.
This is different from calculating the simple moving
average where all data points quite simply just have the
same weight and we're provided with a simple average. The disadvantage
of the simple moving average, some argue, is the fact that
if everything is weighed equally, it's not going to give us
an advantageous look at what is currently happening, which
is where most traders want to focus. With the EMA on the other
hand, it's more responsive to current changes in the market
by placing more weight on the latest developments and price.
Just like the simple moving average, the EMA can also be customized
to the trader's needs and wants. For all of my math savvy traders out there,
if you are one of them, this is the formula of exactly how the exponential moving
average is calculated, as well as the multiplier.
What we have here is a situation where this T is going
to be representative of the instance that needs to be calculated.
That means, if a T 1, a T minus 1 I should say, is in the equation,
that means it's the previous instance, hence the minus 1 portion.
Other than that, it's relatively self-explanatory.
We have our closing price, our multiplier, plus
our EMA, and then we have our 1 minus our multiplier.
Once again, our multiplier is going to be our smoothing
factor divided by, 1 plus the number of days. The math as
far as the calculation of the exponential moving average
isn't overly complicated, but it is not something that you
will most likely need to ever
do. I only share this so you understand exactly how it's coming
from instead of just taking my word, or the indicator's
word, which of course, I never encourage blindly following
anything. When we put the qualities of a simple moving average
on the left with the right side being the exponential moving
average in the same areas,
we can start to see how they really differ. With the simple moving average,
we know that it treats each data point equally with weight
for each data point being 1 over n, where n is the number
of days. Put simply, the simple moving average is quite
literally a simple average of a period that is being averaged
together. The EMA is going to put more weightage on the recent
data points, like we discussed, by replacing the weight used
in the SMA by a multiplier. With the simple moving average over here on the left, only
the number of days can be changed to alter the sensitivity
of the simple moving average line. With the exponential moving
average, the scaling factor
and the number of days can be adjusted to change the multiplier.
With the simple moving average,
it is less responsive to the latest price point because everything
is equal in a simple moving average. With the EMA,
it is more responsive to the latest price point. With the
SMA, we are slower in detecting a trend or a reversal of a
trend more or less due to the point right above it;
The fact that it's less responsive to the latest price point. Whereas with the EMA,
we are faster at detecting a trend or a reversal of a trend
because it's paying more attention to current price. With
the SMA, for calculating the n-day SMA, where 1 n is the number
of days, a history of points are required.
But with the EMA, a history of n plus 1, n plus 1 price points
is required. The first EMA
however, would be based on an SMA, since a historical EMA is
unavailable after the completion of n plus 1 days. Now, if
this is sounding confusing, I promise you it's not nearly
as confusing once we throw one on the graph here and play around with it,
and that's exactly what we're going to do.
Here, we have a graph of the E-mini S&P 500 with two exponential
moving averages already applied to the chart.
One of the exponential moving averages is set to a setting of 12 periods.
That is the blue line. The orange line is a period of 26 as far as the setting goes,
and the reason behind this is the 12 and 26 period EMA crossover
is one of the most common EMA strategies that traders are using today.
The idea is quite simple. Traders are using price action in
conjunction with paying attention to when the 12 and 26 period
EMA's cross over each other, and regarding which direction
they cross will dictate which way they're looking to trade.
Over here where we have A marked off, we can see that the
blue line, which is our 12 period EMA, the shorter-term one
which will follow price closer, is crossing below the orange
line, which is the 26 period. This is a read for traders
using this strategy to look for an opportunity to sell because
it is an indication of bearish momentum.
It should be noted that this strategy can and is applied
with simple moving averages as well,
but the timing of the crosses will vary because once again,
the more recent data with the exponential moving averages
is weighted heavier, which in some regards, will cause these
crosses to happen sooner, which is what a lot of traders are
usually looking for. They want the earlier signal, but it's
only going to be a matter of preference as to which one is going to be your favorite,
so I recommend trying out with both of them.
As these lines continue on, we notice another scenario
occurring. We watched over here where A happens again, where
the lines then cross back the other way. That means the 12 period
crossed on top of the orange line, which is the 26 period.
When this occurs, traders are usually using this as an indication to go long.
It's an expectation of bullish momentum because the short-
term is getting ahead of the average of the longer-term, being
the 26 period. This is the 12 26 period crossover strategy.
Traders will use this strategy to look for an opportunity
to get in for both long and short, and usually they can use
the same strategy that they're using to get in as the reason
to close out a position as well.
If we look at this second A example where we would have gotten
in for a long, the next time the lines cross we can
use that as an opportunity to exit, which occurred over here,
so we could decide to close our trade out at this point because
the same reason that we would want to get out of a long position,
is the same reason that the EMAs are now telling us that
we have bearish activity to come, and obviously we don't want
that to be occurring if we're in a long position.
Another variation of the EMA crossover strategy that's quite
popular is done with the 5 and 8 period settings.
Now, this is going to be one that is going to respond way
quicker, and we're going to see these lines much closer together
on average than with the 12 and the 26 period just because
5 is closer to 8 in regards to what they're measuring.
As such, there's not going to be an expected large deviation
between 5 and 8 as you may see with something that
is 12 to 26, where a lot of different periods in between 12
and 26 quite obviously. With the 5 and 8 EMA strategy,
this is one that is favored by traders that are attempting
to get quick scalps out of the market because it responds so quickly.
It may be hard to see, but over here at our A setting, we actually
had our blue line cross above our orange line.
In this case, the blue line is representing the 5 and
the orange line is representing the 8,
so this would be our opportunity to go long. With our B over
here, we have it going the other way around, ignore the fact
that I apparently can't draw circles, and we crossed the other
way around. We had the blue line fall below the orange
line, which is an indication of potential bearish momentum to come.
Once again, these lines are much closer together in terms of the periods,
so they will cross back and forth over themselves far more
frequently, or may even look like they're just riding on top
of each other to the untrained eye.
This strategy favors a more experienced trader, due to
the fact that the lines are so together so frequently. As
far as using an exponential moving average as part of our
technical indicator tool bag, there are some notable advantages.
We have the fact that it is simple to use.
It is literally a line that is illustrating an average of what price has been doing.
It's also very versatile. It's versatile in the fact that it can be used on essentially
anything that can be charted. On top of that, it's applicable to both long-term
and short-term analysis. It doesn't matter if it's a 5 minute chart or a monthly
chart. An average will always be an average, whether it's the
exponential kind or the simple kind. This applies to both.
It's versatile, easy to use, and can be used pretty much
anywhere on any time frame.
There are some potential drawbacks that should be mentioned
as well, such as the ability for it to create false signals.
Now, the false signals are something that is going to come
from the moving averages potentially crossing over themselves
preemptively while the market is moving itself into a range
in the case that you are using a moving average cross strategy,
like we already discussed. It's up to the trader to make sure that they're using
outside analysis instead of just blindly following the moving
average alone. Also, it is a delayed read. It's a lagging indicator in nature.
It is going to follow behind price, which means it is never
going to be up to the exact moment of what is happening in
the market because it's averaging historical data that has
already occurred together, whether it be the simple or the
exponential. Then, we have the fact that it does work better
in conjunction with price action, which honestly kind of
ties into what I was just saying with the false signals category.
It's not much of another drawback, it's more of a another way to touch on it.
That's once again, it is something that really doesn't do tremendously
well as a pure stand alone strategy, but once we apply it
with something as simple as paying attention to outside price
action or some type of other candlestick patterns, it can
become a very, very powerful tool without a whole lot of extra
input. Let's take a look at the live charts that we applied
the EMA to at the very beginning of the video
now that we understand some of the strategies that can be
used with EMA's, as well as how it works. As we can see here,
when we're scrolling through the charts,
there's some notable things that are happening here that
should definitely draw some attention to your trading brain.
One of them is the fact that when the moving average
is below price, or when it's above price, during a trending market,
the market will at times almost use it as a dynamic area of support or resistance.
If we focus in on this portion of the chart right here,
we can see that during this period of time, we had a break
right here on the left. Price broke above the moving average,
then it continued to ride and bounce on top of it as it
travelled higher, and higher, and higher, until ultimately, it
broke and fell below price, at which point you saw a lot of
resistance being treated around, or being created around the
area that the moving average is now being plotted.
The moving average can do a lot of stuff for us.
It can be an opportunity to get into the market for both
longs and shorts when we use two of them in conjunction
with each other, and then pay attention to the moments when
a shorter-term one crosses over a longer-term one and vice
versa. Also, we can pay attention to them even just by
themselves as a potential area of support or resistance, almost
like a trend line. When the market is working its way upwards,
the moving average is going to hold to a certain degree, obviously
adhering to its average, and price will at times find a way
to magnetize to it and bounce off of it while it's maintaining
a certain trend. If it's a bullish trend, you'll notice
that the market will at times continuously bounce off of
it, like we saw here, and the same will hold true in any bearish
market. The moving average is one that is so darn simple to use,
I think everybody should be aware of how to use it and what
it is, but it is something that has the ability to be applied
to a million other strategies as well because of how clean it
is. It's literally just a line that is going to move through
your current price charts, whether they're candlesticks or
whatever you have them apply to, you can apply the moving
average to anything on any time frame, like we said. It
can always be used as an added layer of confirmation for other strategies
if you're not interested in using it as your main strategy
with a cross plus price action. Other than that, I appreciate
all of you joining me for another Survival Guide here with your old pal, Chris.
Before you go today, please if you can do me a favor
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Until next time guys, happy hunting and happy trading.
I'll see you all very soon.