Friday, May 2, 2014

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Exponential Moving Average (EMA)

The Exponential Moving Average (EMA) weighs current prices more heavily than past prices. This gives the Exponential Moving Average the advantage of being quicker to respond to price fluctuations than a Simple Moving Average; however, that can also be viewed as a disadvantage because the EMA is more prone to whipsaws (i.e. false signals).

The chart below of eBay (EBAY) stock shows the difference between a 10-day Exponential Moving Average (EMA) and the 10-day regular Simple Moving Average (SMA):
exponential moving average reacts faster to price changes than the simple moving average

The main thing to notice is how much quicker the EMA responds to price reversals; whereas the SMA lags during periods of reversal.
The chart below of the Nasdaq 100 exchange traded fund (QQQQ) shows the difference between moving average crossovers (see: Moving Average Crossovers) buy and sell signals with a EMA and a SMA:
three simple moving average crossover buy and sell signals
As the chart above of the QQQQ's illustrates, even though EMA's are quicker to respond to price movement, EMA's are not necessarily faster to give buy and sell signals when using moving average crossovers.
Also note that the concept illustrated in the chart above with Exponential Moving Average crossovers is the concept behind the wildly popular Moving Average Convergence Divergence (MACD) indicator; (see: MACD).
Since Exponential Moving Averages weigh current prices more heavily than past prices, the EMA is viewed by many traders as quite superior to the Simple Moving Average; however, every trader should weigh the pros and the cons of the EMA and decide in which manner they will be using moving averages.
Nevertheless, Moving Averages remain the most popular and arguably the most effective technical analysis indicator out on the market today.

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