The exponential moving average (EMA) is one of the most commonly used forex trading tools. Traders use the EMA overlay on their trading charts to help determine the best entry and exit points of a trade based on where the price action sits on the EMA.
If it is high, the trader may consider a sale or short sale. If it is low, it may be a buy.
Key Takeaways
- The EMA is a useful forex trading tool to help determine entry and exit points.
- Using the EMA should be used in conjunction with other trading tools such as moving average convergence divergence (MACD) and the relative strength index (RSI).
- Forex traders will often encounter some resistance or support when encountering long-term EMA crossover points and will see a significant increase in volume.
Understanding EMA
The EMA differs from a simple moving average (SMA) in two primary ways: more weight is given to the most recent data and the EMA reacts faster to recent price changes than the SMA.
The EMA is very popular in forex trading, to the extent that it is often the basis of a trading strategy. A common forex trading strategy that uses EMAs relies on selecting a shorter-term EMA and a longer-term EMA and then trading based on the position of the short-term EMA in relation to the long-term EMA.
A trader would then enter a buy order when the short-term EMA crosses above the long-term EMA or enter a sell order when the short-term EMA crosses below the long-term EMA.
When EMA numbers such as a 20 EMA or a 10 EMA are referred to, the number signifies the preceding time period selected by the trader. This is usually expressed in days, so a 20 EMA means the EMA is an average of the preceding 20 days, and a 50 EMA means it is an average of the preceding 50 days.
Using EMA Crossovers as a Buy/Sell Indicator
When considering strategy, a trader might use crossovers of the 50 EMA by the 10 or 20 EMA as trading signals.
Another strategy that forex traders use involves observing a single EMA in relation to price to guide trading decisions. As long as the price remains above the chosen EMA level, the trader remains on the buy side; if the price falls below the level of the selected EMA, the trader is a seller unless the price crosses to the upside of the EMA.
Common EMA Timelines
The most commonly used EMAs by forex traders are 5, 10, 12, 20, 26, 50, 100, and 200.
Traders operating off of the shorter timeframe charts, such as the five- or 15-minute charts, are more likely to use shorter-term EMAs, such as the 5 and 10. Traders looking at higher timeframes also tend to look at higher EMAs, such as the 20 and 50. The 50, 100, and 200 EMAs are considered especially significant for longer-term trend trading.
As every investor knows, past performance does not guarantee future results. However, forex traders use the EMA because it can tell them if a certain point in time—regardless of the specified timeframe—is an outlier compared to the average of the timeframe.
What Is the Forex?
The forex is the foreign exchange market. Sometimes referred to as the FX, it is a global, 24-hour marketplace for the trading of currencies. It is electronic and decentralized, having no owners and no headquarters.
Currency exchanges are necessary for any business that conducts transactions across borders. Central banks trade in the forex to stabilize their own currencies. Trading is also conducted by big financial institutions and by individual traders, who make money on the constant fluctuations in the value of one major currency against another.
Why Does the U.S. Dollar Go Up or Down in Value?
No currency goes up or down in value on its own. It goes up or down in value in comparison with another currency. Trading is done in pairs. For example, you could buy EUR/USD, meaning you're buying euros with U.S. dollars. If the euro strengthens in relation to the dollar, you make a profit. If the euro weakens in relation to the dollar, you lose money.
Do Individual Investors Trade in the Forex?
Most participants in the forex are professional traders, either working for a financial institution or on their own. The internet has made it possible for individual investors to participate in the forex.
Many forex brokers manage trading platforms on the web.
The Bottom Line
Foreign currency traders use a number of tools to help them establish buy and sell points for the currencies they trade based on price trends. One of these is the exponential moving average (EMA). Traders typically use a short-term and a long-term EMA to trace the point of convergence between the two.
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