EMA trading strategy: An educational guide

Explore how you can use the exponential moving average (EMA) for trend identification, with practical trading strategies, and risk management – helping you inform your CFD trades.

The EMA trading strategy is a trading approach that uses the exponential moving average, a technical indicator to help identify market trends and highlight possible entry and exit points for trades.

The exponential moving average (EMA) is a type of moving average that gives greater weight to more recent prices, making it more sensitive to short-term market conditions, compared to the simple moving average (SMA).

While most CFD trading platforms – including ours – calculate the EMA automatically, understanding how it works can help you to use it more effectively.

To calculate the EMA, you first find the initial SMA for your chosen period. This acts as the starting value. You then use the EMA formula, which combines the previous day’s EMA (multiplied by a smoothing factor) with today’s price.

A potential advantage of the EMA is how quickly it can react to price changes, which may help you identify new trends and reduce market noise. However, this same sensitivity means the EMA can produce more false signals in volatile markets.

The EMA formula is:

Where:

• EMA today is today’s EMA value.
• Price today is the closing price for the day.
• N is your chosen period (number of days) for the EMA.
• EMA yesterday is the EMA value from the previous day.

If you don’t have the previous day’s EMA, you can start by calculating the SMA over your chosen period and use that as your base.

EMA indicator settings

Setting up the EMA indicator involves choosing a time period over which the average is calculated, as well as an appropriate smoothing factor. Adjusting these settings allows you to tailor the EMA to fit your trading preferences.

For example, day traders may use a shorter period with the aim of more effectively responding to recent price movements, while position traders might choose a longer period to capture broader trends and filter out short-term noise.

The EMA is a versatile tool that can be applied in a variety of ways, depending on your trading approach. Here are some common approaches.

Trend analysis using EMA

To identify the trend, you can observe both the direction of the EMA line and its position relative to the price chart.

If the EMA slopes upwards and sits below the price, it generally points to bullish momentum. When the EMA slopes upwards and above the price, it still indicates bullish momentum, though there may be some resistance present.

If the EMA slopes downwards and it’s positioned above the price, this can suggest a bearish trend. Meanwhile, a downward-sloping EMA below the price may indicate that a downtrend could face resistance.

Consider both the EMA’s direction and its placement relative to price to gain a more accurate view of the prevailing trend.

The EMA can also act as a dynamic support or resistance level, giving you additional insight into potential price reversals or trend continuations. By observing how the EMA line interacts with the price, you can assess the strength of the current trend.

For example, in a downtrend, if the EMA crosses below the price, it may suggest a possible shift towards bullish momentum. Conversely, in an uptrend, if the EMA moves above the price, it could signal an increased likelihood of a bearish reversal.

EMA crossover strategy

An EMA crossover strategy uses two or more EMAs set to different time frames to identify potential trading signals. When a shorter-period EMA crosses above a longer-period EMA, it produces a bullish signal and may indicate the start of an uptrend. In contrast, a shorter-period EMA crossing below a longer-period EMA generates a bearish signal, suggesting a possible downtrend.

Widely recognised crossover patterns include the golden cross and the death cross. A golden cross happens when a short-term EMA crosses above a long-term EMA, pointing to potential upward price movement. A death cross occurs when a short-term EMA moves below a long-term EMA, which may signal downward momentum.

To apply this strategy, you should monitor EMA intersection points and observe subsequent price action. It’s important to consider other technical indicators and the overall market context to help filter out false signals and improve reliability.

For example, if a short-term EMA rises above a long-term EMA, this forms a golden cross and may indicate a bullish trend reversal.

• EMA + moving average strategy: this approach uses a short-term EMA alongside a longer-term simple moving average (SMA). When the EMA crosses above or below the SMA, it can generate buy or sell signals, helping you spot potential changes in trend.
• EMA + RSI strategy: Pairing the EMA with the relative strength index (RSI) can enhance your trend-following strategy. The RSI highlights overbought or oversold market conditions, which you can use to confirm EMA-based signals and refine entry or exit points.
• EMA + MACD strategy: The MACD indicator measures the relationship between two EMAs and can be employed alongside the EMA to confirm trend direction and gauge momentum.

Trading psychology plays a crucial role in the success of any trading approach, including EMA trading strategies. By maintaining discipline, patience, and emotional control, you can help avoid common mistakes such as impulsive trades and overtrading.

Risk management is equally important. Here are some common techniques:

• Setting stop-loss* orders: a stop-loss automatically closes your trade at a predetermined price to help limit potential losses. However, only guaranteed stop-loss can protect from slippage.
• Setting take-profit orders: take-profit orders let you set a target price, so your trade closes automatically when that price is reached, locking in your intended gains.
• Position sizing: adjust your position size according to your risk tolerance, account size, and the specific asset you are trading. This can help you manage exposure on each trade.
• Diversifying trading instruments: trading a range of assets or instruments can spread your risk and reduce the impact of adverse price movements on your overall portfolio.
• Risk-reward ratio: comparing the potential profit and potential loss before entering a trade can help you assess whether the position is worth taking.
• Testing strategy on a demo account: practise and refine your EMA-based strategy using a demo account before trading live. This lets you test different settings and techniques without financial risk.

*Standard stop-losses are not guaranteed. However, we offer guaranteed stop-losses (GSLs) for a fee.

Learn more about risk management in trading.

The EMA indicator can provide valuable insights for identifying market trends and potential entry or exit points. Compared to the simple moving average, the EMA gives more weight to recent price data and responds to current market conditions more quickly.

You can use EMA in several ways, such as analysing the direction of a single EMA, watching for EMA crossovers, or combining EMA with other indicators like RSI and MACD to help inform your trading decisions.