Imagine you’re someone who’s interested in buying and selling stocks or digital currencies. You know how prices can go up and down, right? Well, there’s a special tool that helps traders figure out if these prices are moving in a certain direction, like up (bullish) or down (bearish), over a period of time, and it can help you forecast future price direction. This tool is called the Exponential Moving Average (EMA). Exponential Moving Average (EMA) is similar to Simple Moving Average (SMA), but they work a bit differently. Whereas SMA simply calculates an average of price data by just adding up a bunch of prices and dividing it by the number of prices to get an average. EMA pays more attention to the recent prices because it’s more important to know what’s happening right now.

EMA: Predicting Market Trends Closely

So, if the EMA sees that the recent prices are going up, it’s like a hint that the investment might keep going up in the future. And if it’s going down, it might suggest that the investment could keep going down. People use this to make educated guesses about where the prices are headed.  Because of its unique calculation,  people use it to make educated guesses about where the prices are heading. And here’s the cool part: because EMA gives more weight to the newest prices, it’s like having a magnifying glass on what’s happening lately. This makes it follow the changes in prices more closely compared to the SMA.

It can spot trends before they become super obvious. But here’s the thing, since it’s so sensitive, it can also react to every little bump and wiggle in the prices, which can be both good and tricky. On one side, it can help you identify trends earlier than an SMA would. On the flip side, because it’s super responsive, it might sometimes make you nervous with all the quick changes it shows.

EMA as Market Floor and Ceiling

You can also think of the EMA as creating a sort of invisible floor and ceiling. When the EMA is rising, it’s like a supportive floor underneath the prices, helping them stay up. When it’s falling, it’s like a ceiling that makes it harder for prices to go up. Just like predicting the exact next twist of a roller coaster isn’t easy, the EMA can’t predict the exact top or bottom of the market. It can give you hints about where things are generally headed, but not always the exact moment to jump in or jump out.

Moving averages can also indicate support and resistance areas. A rising EMA tends to support price action, while a falling EMA tends to provide resistance to price action. This reinforces the strategy of buying when the price is near the rising EMA and selling when the price is near the falling EMA.All moving averages, including the EMA, are not designed to identify a trade’s next movement, whether up (bullish) or down (bearish), but could help you guess where they might be headed next. Remember, the EMA is awesome for keeping an eye on wild and crazy market swings. But don’t rely only on it;– it’s better when used with other tools. The EMA can’t guarantee you’ll have perfect timing, but it can definitely help you have a smoother ride! When you use moving averages, there’s a little delay before you notice that a trend has started or ended.

You should notice how the EMA uses the previous value of the EMA in its calculation. This means the EMA includes all the price data within its current value. The newest price data has the most impact on the Moving average, and the oldest price data has only a minimal impact.

How to calculate the EMA, Here’s how it works step by step:

• Start with the Simple Moving Average (SMA): To begin, find the average power level of the character over a certain number of days. Let’s say you want to know the average soft drink brand sold over the last 10 days. You add up their power levels, i.e., the quantity sold on each day for those 10 days, and then divide by 10. Reason because it would be easier for you to compare and find the difference between the EMA and SMA that way.
• Calculate a Smoothing Constant (K): Next, you calculate a number called the “smoothing constant.” This number helps the EMA decide how much weight to give to the most recent power levels. The formula for the smoothing constant is a bit fancy, but it’s like a magic recipe to decide how strongly the recent power levels should affect the EMA.
• Start Figuring Out the EMA: Now, you’re ready to start calculating the EMA. You use the most recent power level (let’s call it “C” for current) and the power level from the previous day (let’s call it “P” for previous EMA).
• Apply the Formula: The formula for the EMA takes the smoothing constant (K), the difference between the current power level (C) and the previous EMA (P), and adds it to the previous EMA. This gives you an updated EMA value.

Exponential moving average using formula

SMA = (N – period sum) ÷ N

SMA= A1+A2+…+An

---

        n

where:

An=the price of an asset at period n

n=the number of total periods.

The weighting multiplier (or smoothing constant, K) = 2 ÷ (time period + 1)

Weighted multiplier (K) =2÷(selected time period+1)

K =2÷(N+1). ​

EMA = (closing price – previous day’s EMA) x weighting multiplier (K) + previous day’s EMA

​

EMA=Price(t)×K+EMA(y)×(1−K)

where:

t=today

y=yesterday

N=number of days in EMA

k= 2÷(N+1) 

OR

EMA = (K x (C – P)) + P

Where: 

C = Current Price 

P = Previous periods EMA (A SMA is used for the first period’s calculations.)

K = the Exponential smoothing constant. Recall that K= 2÷(N+1) 

The smoothing constant K, applies appropriate weight to the most recent price. It uses the number of periods specified in the moving average.

Let’s solve a little example using the two forms.

1. EMA=  (K x (C – P)) + P

Taking the value of:

N = 10, P= $245, C= $290 

Recall that K= 2÷(N+1) 

= (2÷(10+1) x ($290 – $245)) + $245

   (2÷(11) x($290 – $245)) + $245

   (0.1818 x $45) + $245

   $8.181 + $245

   $253.181.

2. EMA=Price(t)×K+EMA(y)×(1−K)

Using the same parameter as used earlier

Taking the value of:

N= 10, EMA (y) = $245, Price (t) = $290 

Recall that K= 2÷(N+1) 

= ($290) x (2÷11) + $245 x (1-(2÷11))

  ($290) x (0.1818) + ($245) x (1-0.1818)

  ($290) x (0.1818) + ($245 x 0.8182)

  $52.722 + $200.459

  $253. 181.

Comparing Exponential Moving Average (EMA) and Simple Moving Average (SMA)

Now, let’s examine a 4-hour chart to showcase the visual contrast between a simple moving average (SMA) and an exponential moving average (EMA) when displayed together on the same chart.

Key Points:

• Using the EMA in trading means that it adapts more quickly to changes in price action, which is an advantage over the simple moving average.
• Exponential moving averages (EMAs) are designed to see price trends over specific time frames, such as 50 or 200 days. The EMA is calculated by giving more weight to the most recent prices.

• Compared to simple moving averages, EMAs give greater weight to recent (more relevant) data.
• Computing the EMA involves applying a multiplier to the simple moving average (SMA).