If you are just starting out on learning the tricks of the crypto trade, you will more than likely already have come across the term “moving average”. It is an important element for any type of analysis and investors, traders, and analysts alike will all take the moving average into consideration when making a move.
The moving average is likely the simplest technical indicator there is, used by crypto trader to identify patterns and predict where the market will go next. The two main types of moving average indicators are the simple moving average (SMA) and the exponential moving average (EMA). In this blog post, we take a closer look at the latter and show how you can apply it to trading crypto.
Structure of Exponential Moving Average (EMA)
To work with the EMA, we must first learn the basics of the SMA.
The SMA takes a specified time period and calculates the average price of a crypto asset during that time. For example, if you set the SMA period at 50 for the BTC/USD market, the technical indicator will show the average price of the last 50 closing prices for BTC/USD. The SMA applies the same weight to all the of the 50 closing prices.
That’s where the EMA takes a different approach. With the EMA, more weight is allocated to the most recent closing prices, which means the more recent closing prices are deemed more important than the older closing prices.
To calculate the EMA, we must first define the SMA time period and then include the multiplier for weighting the EMA.
(2 ÷ (selected time period + 1),
For our 50-period example, the formula would be:
(2 ÷ (50 + 1)
Finally, we calculate the EMA for the next period by multiplying the EMA from the previous period with a multiplier and then adding EMA from the previous period again. This is the final formula for calculating the EMA:
(Closing price-EMA (previous day) x multiplier + EMA (previous day)
Applying EMA on the crypto markets
If you apply both SMA and the EMA on the same price chart, you will notice that the EMA responds to price changes much more quickly than the SMA does. This is because the EMA applies more weight to the more recent prices.
Just like the SMA, the EMA plays a role in many different trading strategies. As a rule of thumb, crypto traders with a short-term approach use the 12-period and the 26-period EMA. For long-term crypto trading, it makes more sense to use the 50-period, 100-period and 200-period settings.
The simplest way of interpreting signals that the EMA is generating is by looking at the trend direction. Reading the trajectory shows you whether the market is downtrending or uptrending. More advanced crypto traders will actually multiple EMAs to find crosses. For example, if a 50-perdiod EMA crosses above a 100-period EMA, that generates a signal indicated the long-term price momentum is moving to the upside. This is because EMAs with a higher period tend to reverse at a slower pace than those with lower periods.