How to apply exponential moving average with crypto trading
Even if you are just beginning to trade crypto, you must have heard of the “moving average” term being used by investors, traders, analysts, etc. The moving average (MA) is arguably the simplest technical indicator used by crypto traders to predict future trends and identify patterns.
The two most common types of moving average are the simple moving average (SMA) and the exponential moving average (EMA). In this blog post, we take a closer look at EMA and the best ways to apply and trade this indicator.
Structure of Moving Average
The SMA calculates the average price of an asset over the specified period. For instance, if the SMA period is set at 100 for BTC/USD, the indicator will show the average price of the last 100 closing prices for BTC/USD. While SMA applies equal weight to all 100 days, EMA distributes more weight to most recent closing prices. This means that the more recent data points have a higher importance than the older ones. For this reason, EMA is also referred to as the exponentially weighted moving average.
The EMA is calculated by defining the SMA period first, and then calculating the multiplier for weighting the EMA.
Usually, crypto traders use the following formula for the multiplier:
[2 ÷ (selected time period + 1)], hence our formula would be [2 ÷ (100 + 1)], as we are using 100-period in our example.
Finally, we calculate the EMA for the next period (or day if you are applying EMA on a daily chart) by multiplying the EMA from the previous period with a multiplier and then adding EMA from the previous period again.
[Closing price-EMA (previous day)] x multiplier + EMA (previous day)
The charting tool used on Sparkdex allows users to easily apply EMA to a chart by simply selecting “Moving Average Exponential” from the drop down menu of indicators.
In this particular example, we set EMA at 100, and in this case it is calculating the hundred most recent closing prices with a focus on the weighted distribution. The price chart below shows the applied 100 EMA indicator.
SMA and EMA on the same price chart
For reference, we applied both the 100 SMA (the red line) and the 100 EMA (the blue line) on the same price chart below to show the difference between the two indicators.
The first thing you will notice is that the EMA adapts to price changes more quickly than the SMA. Logically, this happens as the EMA pays more attention to the most recent price movements than SMA does.
Crypto traders use the 12-period and the 26-period EMA in the short-term. On the other hand, 50-period, 100-period and 200-period are the most popular averages long-term.
As it is the case with the simple moving average, the exponential moving average can play its role in many different trading strategies. The simplest way of interpreting signals that the EMA is generating is by looking at the trend direction.
Due to its structure, basic reading of the EMA trajectory shows whether the market is uptrending or downtrending. Unlike the SMA where the moving average can lag behind the price, the EMA tends to vigilantly follow the most recent price developments.
For instance, on the EMA price chart, you can see that the EMA that follows a downtrending market. As the price action starts to range and trade in more neutral market conditions, the EMA flattens as well.
Besides the market trajectory, many crypto traders use multiple EMAs to look for crosses. For instance, if a 20-period EMA crosses above a 50-period EMA, a signal is generated that short-term price momentum is moving to the upside, as EMAs with higher period tend to reverse at a slower pace than those with lower periods e.g. 12, 26, 20, etc.
Another simple strategy is to use EMA in a similar fashion to SMA - look for it to act as a support or resistance.
The EMA price chart shows multiple points in the past when the price action responded when it touched the 100 EMA. Scalpers tend to use EMA as an object of which the price action may bounce off of, especially on the lower time frames.
Simple but useful indicators
Unlike the simple moving average, the exponential moving average distributes its weight toward the most recent closing prices, therefore providing the more recent data points with a higher importance than the older ones. The EMA is easily applied on almost all charting tools, including the one of Sparkdex, which equips crypto traders with a simple but useful indicator to generate trading signals and profitable opportunities.