Entry-Exit Strategy Using 20 EMA and 200 EMA Crossovers
Entry-Exit Strategy Using 20 EMA and 200 EMA Crossovers Trend Indicator is the Moving Average. Moving averages come in a variety of flavors. Typical examples are the Simple Moving Average (SMA), the Exponential Moving Average (EMA), and the Smoothed Moving Average (SMMA).
For your knowledge, any strategy that utilizes a moving average is a trend trading strategy. When prices are trending up or down, the Moving Average works effectively. Moving average strategies do not work well in choppy or sideways markets. As a result, we usually avoid moving average strategies in choppy or sideways markets. Otherwise, the probability of hitting stop loss increases.
Let us examine the crossover Entry-Exit strategies using the 200 Exponential Moving Average (EMA) and the 20 Exponential Moving Average (EMA). First, we must understand what an Exponential Moving Average (EMA) is and how it is calculated (EMA).
What Is an Exponential Moving Average (EMA)?
An exponential moving average (EMA) is a type of moving average (MA) that gives the most recent data points more weight and relevance. Additionally, the exponential moving average is called the exponentially weighted moving average. A moving average that is exponentially weighted responds more strongly to recent price changes than a simple moving average (SMA), which gives equal weight to all observations in the period.
The chart below illustrates the relationship between the SMA and the EMA. On the left side of the chart, the 200-EMA sees responding sooner to the highlighted price decrease. A similar increase is evident when the price increases, illustrating the variation in latency.
The Formula and Calculation of EMA
Almost every charting calculation does this calculation on their platforms and then applies it to the chart. The formula is presented below for the mathematically oriented, but the important aspect to understand is that the EMA reacts to price changes faster than the SMA.
The exponential moving average (EMA) is a weighted moving average created by adjusting the average price for a market over a while. The formula below decomposes the calculation into its parts, making it simple to see and calculate.
Calculating the EMA takes one more observation compared to calculating the SMA. Assume you wish to utilize twenty days as the observation period for the EMA. Then, on the twentieth day, you must receive the SMA. On the twenty-first day, use the previous day's SMA as the first EMA.
SMA is a simple calculation to calculate. It is the sum of the stock's closing prices over time divided by the number of observations. A twenty-day SMA, for example, is just the sum of the closing prices for the previous twenty trading days divided by twenty.
Following that, you must calculate the multiplier for smoothing (weighting) the EMA, which expresses as [2 (number of observations + 1)]. The multiplier for a twenty-day moving average is [2/(20+1)]=0.0952.
Finally, the current EMA calculates using the following formula:
EMA = Closing price x multiplier + EMA (previous day) x (1-multiplier)
The EMA prioritizes recent prices, but the SMA provides equal weight to all values. For a shorter-period EMA, the weighting assigned to the most recent price is broader than for a longer-period EMA. For example, for a ten-period EMA, a multiplier of 18.18% applies to the most recent price data, but the weight is just 9.52% for a 20-period EMA.
Furthermore, the EMA computed using the open, high, low, or median price rather than the closing price has slight differences.
Using EMA in a Forex Trading Strategy
The EMA distinguishes from a simple moving average (SMA) in two key ways: it gives greater weight to recent data and responds more quickly to recent price movements than the SMA. The EMA is quite popular in forex trading, to the point that it uses as the foundation for a trading strategy. A typical forex trading strategy that makes use of EMA to choose a shorter-term and a longer-term EMA and then trades depending on the short-term EMA's position with the long-term EMA.
When the short-term EMA crosses above the long-term EMA, the trader will place a buy order; when the short-term EMA crosses below the long-term EMA, the trader will place a sell order. When EMAs denote by the numbers such as a 20 EMA or a 10 EMA, the previous period chosen by the trader denotes by this number. This figure usually expresses in days; for example, a 20 EMA represents the average of the previous 20 days, a 50 EMA equals the last 50 days, and so on.
EMA Crossovers as a Buy/Sell Signal
When developing a strategy, a trader may look for trading indications in crosses of the 50 EMA by the 10 or 20 EMA. Another strategy used by forex traders is to utilize a single exponential moving average (EMA) with the price to influence their trading selections. As long as the price stays above the specified EMA level, the trader is a buyer; if the price goes below the chosen EMA level, the trader is a seller until the price crosses above the EMA.
The 5, 10, 12, 20, 26, 50, 100, and 200 EMAs are the most often utilized by forex traders. Traders that trade on shorter time frames, such as five- or fifteen-minute charts, are more likely to employ shorter-term EMAs, such as the five and ten-minute EMAs. Traders that trade on higher timeframes are also more likely to use higher EMAs, such as the 20 and 50. The 50, 100, and 200 EMAs regarding as particularly important for longer-term trends trades.
The EMA is so popular because, although previous performance does not guarantee future outcomes, traders may evaluate if a particular moment in time, regardless of the period selected, is an outlier compared to the timeframe's average. In Metatrader4 or Metatrader5, the Exponential Moving Average is the default indicator.
Below is a plot of the Metatrader4 Exponential Moving Average.
Open MT4 > Insert > Indicator > Trend > MA> Exponential > OK
Let us explore strategy:
When the price is above the 200 Exponential Moving Average, we will decide to buy. Additionally, we will sell when the price falls below the 200 Exponential Moving Average. The 20 Exponential Moving Average (EMA) will use a pullback or retracement strategy. That is, we establish Buy Limits or Buy Stops and Sell Limits or Sell Stops when the price returns to the 20 Exponential Moving Average, either near, below, or touching it (EMA)
Ensure that the price is slightly above the curve of the 200 Exponential Moving Average.
The 20 Exponential Moving Average surpasses the 200 Exponential Moving Average, indicating an upward trend.
Let's wait for the price to revert to the 20 Exponential Moving Average, either near, below, or touching it.
Keep an eye out for bullish reversal candlestick patterns in price activity (PIN BAR, BULLISH ENGULFING, MORNING STAR, HAMMER, HARAMI, PIERCING, and DOJI)
Entry: place a buy stop pending order at least two to five pips above bullish reversal candlesticks in price movement. Stop Loss: two to five pips below bullish reversal candlesticks or close to swing low. Take Profit: locating near resistance/swing highs or at a risk-reward ratio of 1:2 or 1:3.
Ascertain that the price is below the arc of the 200 Exponential Moving Average.
The 20 Exponential Moving Average crosses the 200 Exponential Moving Average, indicating that the trend is downward.
Let's wait for the price to revert to the 20 Exponential Moving Average, either near, below, or touching it.
Keep an eye out for bearish reversal candlestick patterns in price activity (PIN BAR, BEARISH ENGULFING, SHOOTING STAR, HARAMI, DARK CLOUD COVER, and DOJI)
Entry: placing a sell stop pending order at least two to five pips below bearish price action reversal candlesticks. Stop Loss: two to five pips above or near bearish price action reversal candlesticks. Take Profit: locating near Support / Swing Low or at a risk-reward ratio of 1:2 or 1:3.
For your information, each strategy includes several advantages and disadvantages. Let us examine the advantages and disadvantages of the 200 Exponential Moving Average and 20 Exponential Moving Average crossover strategies.
This strategy is straightforward and straightforward. Additionally, it is simple to understand and execute.
In a trending market, this strategy will earn you a lot of pips if executed correctly.
This strategy works well as a swing trading strategy as well. You will enter and exit simultaneously until the price crosses below 200. Exponential Moving Average (for BUY) or above the 200 Exponential Moving Average (for SELL).
Additionally, this strategy's Risk-Reward Ratio is good.
The Exponential Moving Average is not a leading indicator. It is, thus, a lagging indicator. As a result, it has recently provided a buy or sells signal. After the price moves ahead, the Exponential Moving Average indicator provides us with a buy or sell signal.
The EMA's Limitations
Many traders feel that fresh data more accurately reflect the security's current trend. Others argue that emphasizing recent dates creates a bias that leads to more false alarms. According to many economists, markets are efficient, which means that current market prices already reflect all available information. If markets are efficient, previous data should provide us with no insight into the future direction of asset values.
As a trader, the EMA is a vital indicator to have. This indicator is easy to use and helps new traders understand technical analysis to identify trends and entry points. Although more experienced traders often employ the EMA in conjunction with other techniques, this does not diminish its significance.
The following are the steps to follow while trading using the EMA:
Use a long-term exponential moving average to establish a broad trend.
Identify crossover locations between shorter and longer-term exponential moving averages
Take care to input the appropriate long or short positions.
IMPROVE YOUR TRADING SKILLS WITH OUR TRADING TIPS:
Examine the fundamentals of the conventional moving average in addition to implementing the 200-day moving average into your trading strategies.
Technical traders use a variety of trading styles and strategies. Explore them extensively to find if this type of analysis is a good fit for your personality.
If you are only starting your trading career, it is essential to understand the basics of forex trading in the instaforex tutorial section.
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