Foreign exchange traders overlay the exponential moving average (EMA) on their trading charts to help decide the most favorable entry and exit points for a currency trade.
Users of the EMA, in the forex and other markets, look for buy and sell signals in EMA crossovers. A crossover occurs when a short-term EMA crosses above or below a long-term EMA. A crossover above a long-term EMA is seen as a bullish signal. A crossover below a long-term EMA is a bearish signal.
The EMA is one of the most commonly used forex trading tools.
Key Takeaways
- The EMA is a useful forex trading tool to help determine buy and sell points.
- Forex traders often encounter some resistance or support when encountering long-term EMA crossover points and will see a significant increase in volume.
- The EMA should be used in conjunction with other trading tools such as moving average convergence divergence (MACD) and the relative strength index (RSI).
Understanding EMA
A moving average, in forex and stock trading, is a series of calculations of an asset’s average price movements over time. It is useful for smoothing out random short-term fluctuations and showing the real price trend more accurately.
There is a simple moving average (SMA) as well as an exponential moving average, but traders prefer the latter for two reasons: it gives more weight to the most recent data, and it reacts faster to recent price changes.
Using EMA on the Forex
Forex traders tend to be particularly reliant on the EMA, to the extent that it is often the basis of a trading strategy. One common forex trading strategy 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 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.
Forex Terminology
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
A trader might use crossovers of the 50 EMA by the 10 or 20 EMA as a trading signal.
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 above the EMA.
Common EMA Timelines
The most commonly used EMAs by forex traders are 5, 10, 12, 20, 26, 50, 100, and 200 days.
Traders operating off of 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 national 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.
That’s why forex trading is always 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 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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