An Exponential Moving Average is a technical analysis trading indicator. Abbreviated to EMA, it allows an optimized understanding of the market’s evolution, be it to confirm an existing trend or to detect a trend reversal. It allows the buyer or seller to identify the right moment for action. Its main difference from the Simple Moving Average is that the Exponential Moving Average places more importance on recent price fluctuations.
What is the difference between the Simple Moving Average and the Exponential Moving Average?
The Exponential Moving Average is a type of Moving Average that aims to assign a coefficient whose value is proportional to the freshness of the period under study. Its calculation formula allows to give more weight to the recent periods of a price, compared to the older periods. Thus, the EMA follows the prices quicker than the SMA. Exponential Moving Averages allow to detect trends more quickly than Simple Moving Averages.
On this chart, you can see the 25-period Simple Moving Average in yellow and the 25-period Exponential Moving Average in blue. The Exponential Moving Average follows the price more quickly than the Simple Moving Averagd. Thus, when the market is bullish, the EMA is above the SMA, and crosses below it when the market becomes bearish.
How to calculate the Exponential Moving Average?
The formula to calculate the exponential moving average is more complex than the formula to calculate the Simple Moving Average. It is calculated by taking into account three elements: the multiplier, the current price and the previous day’s exponential moving average. To calculate the EMA, the multiplier must be expressed as a percentage. The current price defines the value of the asset under analysis at time T, and the exponential moving average of the previous day logically takes the value of the MME of the previous day. The formula for calculating the exponential moving average is therefore as follows:
EMA = EMAN-1 + M x (PriceN – EMAN-1)
M is the multiplier, EMAN-1 is the previous period’s average, and PriceN is the current price. The multiplier is calculated as follows :
M = 2 / (1 + N)
The first Moving Average is a Simple Moving Average.
Technical Indicators using Exponential Moving Averages
Several technical analysis indicators are built using Exponential Moving Averages. They can be used with the close price of the asset, or even to smoothen signals of other indicators themselves. The MACD (Moving Average Convergence Divergence) is one of the most popular ones, using 2 Exponential Moving Averages to determine trend reversals and trend strength.