The use of moving averages is very common in trading. Moving averages are popular among traders around the world because of their simplicity and ease of use. There are variations of moving averages like simple and exponential. A simple moving average calculates a plain vanilla average by adding all the prices from a certain lookback period and then dividing the sum by the number of periods. 

The exponential moving average is a very popular technical indicator as well. Its formula is more complicated than a simple average. It involves calculating a smoothing factor that is intended to give more weightage to the recent prices when calculating the average. So, as you may have guessed, a moving average is more biased towards recent prices than the ones farther back in the lookback period. The simple moving average gives equal importance (weight) to all prices in the lookback period. Some traders call the exponential moving average the “exponentially weighted” moving average as well.

The exponential moving average “hugs” the price more closely than the simple moving average. One of the criticisms that moving average indicators receive is that they give signals too late when a trend change or a breakout has already occurred with significant price movement. Traders want their signals earlier so that they can capture a greater portion of trade, especially when the trade goes in their favor. It is like trying to have your cake and eating it too.

Selecting The Lookback Period

The beauty of using moving average indicators is that you can customize them any way you want to. You can simply change the lookback period and use the exponential moving average in different ways to indicate different things. For example, you can try using the 200-day exponential moving average to find out what the long-term trend is.

(BTCUSD daily chart with 200-day EMA   source: cerusmarkets.com)

The chart above shows Bitcoin prices post the 2020 pandemic-led market crash along with the 200-day exponential moving average in red. You will notice that the price did not go below the 200-day exponential moving average. High liquidity levels led to a bull run in stocks and cryptos post the 2020 crash. So, the longer-term trend at that time appeared to be upward and the exponential moving average demonstrated it.

However, if you change the lookback period to 50 days, then it gets interesting.

(BTCUSD daily chart with 50-day EMA   source: cerusmarkets.com)

The 50-day EMA is shown in green. The first thing you may notice is that it follows the price more closely than the 200-day EMA. It is more sensitive to price movements than the 200-day EMA. Also, the price went below the 50-day EMA in late 2020. The shorter lookback period allowed traders to catch the correction of September 2020.

So, depending on what you want to trade, an appropriate lookback period can be selected. If you are looking for, say, short-term breakouts and breakdowns, then a shorter period EMA can work. Buy-and-hold investors and those who want to trade long-term may use a longer lookback period.

Some Strategies Using The Exponential Moving Average

The exponential moving average can show the trend of an asset’s price. One may want to look at not only where the price is but also what the slope of the moving average is. An upward-facing moving average usually indicates an uptrend while a downward-facing moving average indicates a downtrend. In the previous section above, both the 50-day EMA and the 200-day EMA are both facing up in 2021 and the price also rose significantly. One possible strategy at that time could have been to go long when the price came close to the 50-day EMA. A stop loss could have been any level below the 50-day EMA since the price was respecting the 50-day EMA throughout that uptrend.

Another strategy that traders can use is the crossover. It involves using two moving averages simultaneously. One EMA has a shorter lookback period while the other has a longer lookback period. When the shorter moving average crosses above the longer moving average, traders could go long. If the shorter moving average crosses below the longer moving average, traders could go short. The idea behind such crossovers is that the shorter period moving average is more sensitive and therefore will signal the trend change before the longer period moving average will. Crossovers become more significant when the close of both the shorter period and longer period exponential moving averages match the price trend. So, for example, if the trend signal is to go long and subsequently, if both the shorter and longer period exponential moving averages slope upwards, the belief that an uptrend is here to stay becomes stronger.

(LTCUSD 4-hour chart with 18 & 50-day EMAs  source: panda-fx.com)

The 4-hourly chart for LTCUSD shows a downtrend that occurred in December 2022. After a period of choppy sideways movement, the price fell significantly. The 18-day EMA (in blue) crossed below the 50-day EMA (in green). The 18-day EMA kept moving above and below the 50-day EMA during the choppy period. But, post the price fall and the final crossover, both the 18 and 50-day EMAs turned downward sloping confirming the downtrend.

Exponential moving averages can also be used like trendlines to find support and resistance levels. In the LTCUSD example above, notice how the price post the fall does a brief sideways trend. It almost touches the 18-day blue EMA before falling further. In a downtrend, the 18-day EMA acted as a resistance and might have been a good place to go short. A stop loss might have been placed somewhere above the 18-day EMA.

A Word On Risk Management

Trading CFDs is risky as they are leveraged instruments. So, it is always a good idea to have some risk management practices in place. If you are planning to catch trends using the moving average, then it is important to size your positions correctly, place stop losses, and define your risk before taking a trade.

Cerus Markets offers both simple and exponential moving average indicators on its market-leading trading platform. Users can trade CFDs in a host of cryptocurrencies and use moving averages to generate buy and sell signals. We encourage you to open an account as well and take advantage of our 100% welcome bonus offer. As we say at Cerus Markets, there is always a bull market somewhere. We hope you can participate in such trends as well.