The cryptocurrency market is highly speculative in nature, which usually leads to exaggerated levels of volatility. To compensate, investors need to use technical indicators that adapt to the volatility of cryptocurrencies. One such indicator is the exponential moving average (EMA), which is designed to smooth out the effects of price volatility.
Among technical indicators, the moving average (MA) is one of the most commonly used tools to indicate overall trend direction. The exponential moving average focuses on the most recent price data, which is important when trading in the volatile crypto environment. In this article, we’ll discuss how the EMA is used in crypto trading, and we’ll outline different ways to use the EMA, along with practical trading examples.
What Is an Exponential Moving Average?
An exponential moving average is a technical indicator that gives greater weighting to recent prices in its calculation. As a result, EMA responds more quickly to the latest price changes, as compared to a simple moving average (SMA), which has a bigger lag.
The primary aim of the EMA is to smooth out the price and remove short-term price fluctuations.
Most investors focus on SMA, which shows the average price of a specific number of candles. If the current price moves above the average, bulls are stronger than bears. On the other hand, changing direction might indicate a trend change. However, EMA gives more weight to current data because its formula more closely follows the price.
The mathematical formula for calculating EMA builds upon its previous values. Therefore, all price data remains up-to-date so that the newest data has greater impact than the older price data.
EMA = Y + [K × (X − Y)]
X = Current price
Y = Previous period’s EMA (SMA is used for the first period’s calculations)
K = Exponential smoothing constant (this gives the appropriate weight to the most recent prices, utilizing the specified period in the MA)
The EMA clarifies price action for traders by reducing the lag in the price chart. As a result, it smoothes the price and makes the trend more reliable and accurate than with the traditional moving average. However, its greater price sensitivity may at times confuse traders. Therefore, the ideal approach is to use other technical indicators in addition to EMA in order to determine the most accurate buying point.
EMA: Strengths and Weaknesses
As with all technical indicators, moving averages cannot be the ultimate solution for trading cryptocurrencies. Therefore, investors should understand these indicators’ strengths and weaknesses before using them to make trading decisions.
Strengths of the Exponential Moving Average
- EMA shows a more accurate result than SMA because it focuses on the most recent price changes.
- EMA works well for finding the current market trend. Investors can define the possible market movement by looking at whether or not the price is above the EMA.
- Besides indicating trend direction, EMA works as both a dynamic support and resistance level.
- Although EMA is a trend trading indicator, investors can use it to find possible reversal points. The larger the gap between the price and the EMA increases, the higher the reversal possibility.
- Investors can easily combine the EMA with other trading indicators, such as MACD, RSI, stochastic and ADX.
- The golden cross trading strategy uses the 50-period EMA and 200-period SMA to show both short-term and long-term trading sentiment.
Weaknesses of the Exponential Moving Average
- EMA is just one part of a trading strategy, and investors cannot rely solely upon it.
- Although EMA lags less than SMA, it still has some lag, as do other technical indicators.
- In cryptocurrency trading, sharp bullish movement is common, which is not identifiable using the EMA.
- Within the volatile crypto market structure, EMA often provides false signals.
How to Use the Exponential Moving Average to Trade
EMA works like other moving average indicators, where the primary aim is to identify the market trend. If a crypto asset is within an uptrend, the price will be above the EMA. For a bearish trend, the price should remain below the EMA. On the other hand, a contraindication of the EMA would represent a correction in a trend, as shown in the image below.
The above image shows the three phases of a trend, which we can easily find using the EMA:
- Price is stable above the EMA: uptrend
- Price is stable below the EMA: downtrend
- Price becomes unstable at the EMA: correction.
In cryptocurrency trading, investors should find a stable price above the EMA to open a buy position. In addition, a trend trader should understand how to gauge the strength of a trend.
Based on the EMA value, we can define a market trend as follows:
- EMA 12 to 26 days: suitable for finding short-term trends
- EMA 50 to 200 days: suitable for finding medium- and long-term trends
Long-term traders and HODLers should use an EMA of 50–200 days to identify the long-term price direction in cryptocurrency trading. On the other hand, the short-term trend is suitable for opening trades. However, the period of the EMA depends on the trader’s choice and flexibility. Fortunately, this can be easily adjusted to fit your trading plan.
There are many ways to trade cryptocurrencies using EMA. However, professional traders like to keep the system simple, using it where profitability is high.
Trend trading is the basic way to identify where most market participants are most comfortable owning the asset at the current price. In this method, the combination of EMA and SMA has higher probability rates.
For example, we can use a 200 SMA for long-term trends and a 50 EMA for short-term trends. Therefore, crypto investors should buy once the price moves above both the 200 SMA and 50 EMA.
Per the BTC/USD chart above, the long-term trend is bullish as the price exceeds the 200 SMA. Later on, the price moves above the 50 EMA, while the 50 EMA is above the 200 SMA. Therefore, the bullish trend above both MA levels is very strong, and any buying point has a higher possibility of hitting the target level.
Dynamic Support And Resistance
Another approach is to use EMA as a dynamic support or resistance level. One of the biggest drawbacks of static S/R is that it remains fixed at a given level. On the other hand, dynamic S/R levels move with the price and can react immediately. Therefore, this method is suitable for finding near-term reversal points toward the trend.
The above BTC/USD chart demonstrates how the EMA works as a dynamic support. Buying a crypto asset from the dynamic support level has a better risk-to-reward ratio. The 50-day and 200-day moving averages can be used to identify dynamic support and resistance zones from which prices are more likely to react.
EMA Crossover Trading
When one moving average moves above another, it creates a profitable trading opportunity. One of the most effective crossover strategies is known as the golden cross. When the 50 EMA moves above the 200 SMA, it indicates that short-term bulls are becoming more aggressive, while long-term traders are still bullish.
The example above shows how the golden cross indicates increased bullishness in the BTC/USD price. This is applicable in any time frame from one minute to one week.
Exponential Moving Average vs. Simple Moving Average
Cryptocurrency trading differs from traditional financial instruments because big surges and collapses in price are very common with crypto. Therefore, traders aren’t always certain when it comes to choosing the right MA. Moreover, long-term HODLers and intraday traders remain active in cryptocurrency trading, which raises the question of whether they should use EMA or SMA.
SMA uses the average price of the last number of candles without reference to recent price change. Therefore, SMA works well with a higher number of candles. As a result, long-term traders and HODLers can use SMA to identify the broader market context. For example, a 200 SMA provides more accurate indications of a long-term trend than a 200 EMA.
The BTC/USD chart above shows that the 200 EMA is closer to the price than the 200 SMA 200 because EMA focuses on the most recent price changes, which aren’t as much of a necessity for long-term traders.
On the other hand, even if traders know where the long-term trend is heading, it’s important to match it with the short-term trend. It isn’t advisable to buy a crypto asset based solely on its price above the 200 SMA. Moreover, intraday traders don’t bother with where the long-term trend is heading, or they just trade a portion of the broader market trend.
Therefore, EMAs with lower values like 20, 30, 50 or 100 work well for finding the short-term market trend. Optimal success in EMA trading comes from how the trader utilizes the SMA and EMA together to find the most accurate trend.
The BTC/USDchart above shows how the price is trending up both long- and short-term, identified by the 20 EMA and 200 SMA.
Best Exponential Moving Average Indicator Pairings
In financial trading, investors have to anticipate the price movement because no one knows for certain where it’s headed. Using multiple tools, investors can increase the probability of successful trades. Therefore, the EMA needs to be combined with other indicators. The following are some of these possible pairings.
EMA and RSI
The Relative Strength Index (RSI) indicator is an important technical oscillator that indicates overbought and oversold positions. The RSI indicator price chart shows in a separate window, and moves from a level of 0 to 100.
- RSI is at 0–30: price is oversold
- RSI is at 70–100: price is overbought
When the RSI indicator starts to move up above 30, it’s a strong indication that the market may initiate a bullish trend. Later on, a potential buying opportunity may come when the price moves up from the dynamic 20 EMA while the RSI indicator is still bullish.
The above BTC/USD chart shows that the BTC/USD price faces static support at $40,684, and moves above the dynamic 20 EMA with a strong bullish H4 close. In the meantime, RSI is trending higher and has moved above 50. As a result, the price extends to $68,000, indicating a strong bullish trend.
EMA and ADX
ADX, or average directional index, is another momentum indicator that helps traders identify a trend’s strength. ADX remains in a separate window and moves from 0 to 100 and even beyond. For cryptocurrency trading, investors should closely monitor the ADX level while opening a buy position.
Before opening a buy trade using the EMA and ADX, make sure to follow these steps and conditions:
- Identify the long-term trend using the 200 SMA and the short-term trend using the 20 EMA. When the price moves above these MAs, look for a suitable buying opportunity.
- The price moves above any important support level, without any strong resistance near the entry price.
- ADX moves upward and crosses above 20.
- The buy entry is valid as soon as a bullish rejection candle appears from the dynamic 20 EMA.
The BTC/USD intraday chart above shows Bitcoin’s price moving up from the horizontal support level of $50,382.35, and closing with a bullish candle above the dynamic 20 EMA. Meanwhile, the ADX is above 20, indicating that the current bullish trend is strong.
The Bottom Line
To summarize, using EMA to determine entries can be profitable if traders combine it with other trading tools. EMA remains popular among traders because it places more weight on the latest price data, lagging less than other technical indicators. Similar to all moving averages, EMA works best in the midst of a strong trend in the market.