Exponential moving average (EMA) trading refers to buying and selling financial assets when their price touches a major EMA support or resistance level. EMA is different from a simple moving average (SMA) because it applies more weight to recent data points in the time series when calculating an average. SMA on the other hand calculates a simple average of the included time points.
You can access exponential moving average lines on a price chart when you go to the CEX.IO Broker website or alternatively you can use charting websites like Tradingview.
In this article, we will first discuss what a moving average is and the EMA trading strategies commonly used in cryptocurrency trading.
What is a moving average?
A moving average is calculated by averaging out the past prices of an asset over a given time period. Calculating a moving average mitigates the impacts of short-term, random price fluctuations that may trick or confuse traders. As a result, traders may use moving averages to determine whether an asset is in an uptrend or downtrend at a given time frame.
A simple moving average (SMA) calculates the arithmetic mean of past prices realized in a specific time interval, for example over the last 10, 30, 100, or 200 days.
An exponential moving average (EMA) is a weighted average that gives greater importance to recent prices in a given time period. For example, prices in the last ten closings have more weight in a 100-day EMA compared to the previous 90 price points. This makes the EMA more responsive to recent price movements.
Moving averages are useful for identifying support and resistance levels. Buying and selling at certain moving average levels on different time frames is a common practice among traders.
Moving averages generally observed by traders consist of round numbers like 10, 30, 50, 100, 200, etc. So if a daily time frame is used, a trader would be looking at 10, 20, 50-day, etc. moving averages.
In EMA trading, Fibonacci numbers are also commonly used to determine support and resistance levels, such as 8, 13, 21, 34, 55, 89, 144, etc.
EMA trading strategies
There are many strategies to trade the EMAs, but the two most common strategies are:
- Trading EMA support and resistances
- Trading EMA crossovers
Trading EMA support and resistances
There are two major practices in this type of trading:
- Buying a cryptocurrency when its price falls on a major EMA support on the price chart and selling it when the price hits a major EMA resistance.
- Buying a cryptocurrency when its price is significantly below an EMA support level and selling it when the price is significantly above an EMA resistance level.
Buying on support, selling at resistance
Market players tend to buy and sell collectively at certain exponential moving averages in a given time frame. As a result, hitting major EMA support and resistances may initially be followed by a bounce or dump from those levels.
In that sense, you may adopt this strategy to buy and sell at Fibonacci number levels like 8, 21, 55, 89, and 144 EMA on whatever time frame you would like.
The 8 and 21 EMAs tend to be the most popular averages for day traders while the 55, 144, and 200 EMAs are better suited for longer-term investors.
As an example, you can see in the chart below, the 144 EMA for Bitcoin (the dark blue line) on a daily price chart. The 144 EMA seems to have worked as support during Bitcoin’s uptrends and almost accurate resistance during Bitcoin’s downtrends.
Bitcoin/U.S. Dollar chart on a daily time frame with the 144 EMA. Source: Tradingview
The 144 daily and 21 weekly EMAs are two of the most closely followed EMA lines for the Bitcoin/U.S. Dollar trading pair.
However, you should note that EMA support and resistance trading is by no means a 100% safe or accurate trading strategy. Trading is not a deterministic science, so there is no such thing as 100% accurate trading.
A large market whale or too many traders at once may come into play and buy or sell in large quantities that support and resistance levels may not hold at all and you may end up with a substantial loss or sell prematurely.
Bear and bull traps
On the other hand, breaking support or resistance does not always mean a trade has failed or the opportunity is lost. Markets often move with fakeouts to trap you in or trick you out of a trade.
When you get stuck in a trade with the support breaking down or you watch from the sidelines feeling lucky you did not buy, the price action may just be a bear trap to shake out weak hands or discourage sideliners from getting in the position. Bear traps are also set up to liquidate margin short traders.
Likewise, you can buy at support to watch the price grow only to be caught in a bull trap.
To determine whether a breakout is genuine, you need to watch the next few candle closings on higher time frames, compared to your trading frame, to look for confirmation. This is because larger time frames are considered to have more influence in determining the trend.
For example, if you want to trade the 4-hour EMAs, you need to watch the daily closing candles and if you want to trade the daily EMAs, you need to watch the weekly or monthly closing candle, etc. If there are bullish candle closings on the higher timeframe, the probability of a bear trap or vice versa increases.
Buying and selling extreme deviations
You may follow a specific EMA line on a given time frame and buy or sell the asset when its price gets unusually far away from that EMA line, either to the upside or downside.
To do that, you need to measure the distance between the current candlestick and the EMA line of interest using a charting tool. Go back on the chart and take a historical average of retracements or advances from the EMA line and then compare it with the current distance.
You may choose to buy the asset if its price drops below the EMA line by an unusually high margin or sell when it is unusually high above the line.
Regardless of the distance from any major EMA line, you might want to watch for the EMA support and resistance levels on higher time frames before you enter or exit any trade since the major levels on high time frames tend to have more significance in determining trend tops and bottoms.
Trading EMA crossovers
Another common EMA strategy is trading the EMA line crossovers. When a faster (shorter average) EMA crosses up a slower (longer average) EMA on a price chart, it is considered a bullish cross (golden cross) and when a shorter EMA crosses down a longer EMA, it is considered a bearish cross (a death cross).
Traders often choose to buy an asset when their EMA lines of interest make a bullish cross and sell when they make a bearish cross.
The first thing you should know about trading EMA crossovers is that there will usually be a lag in the price action once a crossover happens. The lag tends to get longer with increasing time frames and EMA lengths, such as the 144-day EMA or 200-weekly EMA.
You can see in the chart below a Bitcoin bearish cross, which involves the crossing down of its 55 EMA below the 144 EMA on a 3-day price chart. As you can also see in the chart, although 15 days have passed since the death cross as of this writing, the price has not yet broken out of its sideways consolidation.
Bitcoin/U.S. Dollar 3-day price chart. The green line represents the 55 EMA and the red line represents the 200 EMA.
As a good bullish cross example, you can see in the chart below Zilliqa’s golden cross in 2020 against its Bitcoin trading parity (ZIL/BTC). The 55-daily EMA crossed up on the 144 EMA on May 15 (circled in purple) which was followed by an approximately 500% increase in the parity over the course of a year.
Zilliqa/Bitcoin daily price chart. The green line represents the 55 EMA and the red line represents the 144 EMA with the golden cross circled in purple.
Another thing to note is that moving average crossovers can produce a lot of fake signals, especially in shorter time frames. This includes even daily charts. An EMA crossover on a shorter time frame could end up with the price doing nothing or even moving in the opposite direction.
As is the case with any trading strategy, larger time frames constitute a safer bet in EMA crossover trading such as the 3-day, weekly, or monthly crossovers.
Regardless of which time frame you trade, you should always look for confirmations before you take action on a signal. Even if you trade longer time frames, you should at least wait for a few bullish or bearish candle closings (depending on whether you are a buyer or seller), as well as confirmations from momentum indicators like the RSI and stochastic RSI.
Exponential moving average (EMA) trading is one of the most widely used methods in cryptocurrency trading. There are two primary strategies for EMA trading:
- Buying at EMA support and selling at EMA resistance
- Buying upon an EMA bullish cross and selling upon an EMA bearish cross
Extreme deviations from major EMA support and resistance levels compared to historical deviations can also be treated as a buy and sell signal in EMA trading.
As discussed, none of these are definitive, 100% accurate trading strategies. Like any other trading strategy, these are never 100% accurate.
Fakeouts, traps, invalid signals, and divergences with longer time frames will always be present, so you may consider adjusting your position sizes accordingly and look for as many confluences and confirmations as possible on higher time frames (compared to the time frame you may trade) when you practice EMA trading.
Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.