To make lightning-fast buy and sell decisions, day traders require continuous feedback on short-term price action. This is accomplished by using intraday bars wrapped in multiple moving averages, which allows for quick analysis that highlights current risks (as well as the most advantageous entries and exits). These averages also serve as macro filters, alerting the observant trader to the best times to take a break and wait for better conditions.
Choosing the right moving averages improves the consistency of all technically-based day trading strategies, whereas poor or misaligned settings undermine otherwise profitable approaches. In most cases, identical settings will work across all short-term time frames, allowing the trader to make necessary adjustments based solely on the length of the chart.
Given this consistency, an identical set of moving averages will work for scalping techniques as well as morning and afternoon buying and selling. The trader reacts to different holding chart periods solely based on chart length, with scalpers focusing on 1-minute charts and traditional day traders examining 5-minute and 15-minute charts. This process even includes overnight holds, allowing swing traders to use the averages on a 60-minute chart.
What Exactly are Moving Averages?
Moving averages (MAs) are among the most effective technical tools for making trading decisions. Indeed, they are so widely used that they serve as the foundation for many technical indicators, including Bollinger Bands, Envelopes, Average Directional Movement Index (ADX), and MACD.
Moving Average Varieties
Moving averages represent the average price of an asset over a given time period. Moving averages are classified into several types.
The most common type of MA is the SMA, which calculates the average price of an asset based on the number of periods in that range.
By prioritizing recent prices, the EMA eliminates the lag in SMAs.
Weighted Moving Averages (WMA)
The WMA eliminates lag by discounting the weight of an asset's "ancient" prices.
Smoothed Moving Averages (SMA)
The smoothed moving average eliminates lag by calculating the average over a longer period of time. As the SMA is calculated, it assigns a weight to the price.
Other types of moving averages include least squares moving averages, hull moving averages, and Arnaud Legoux moving averages. The chart below depicts how the Nasdaq 100 index was affected by the 25-day EMA, SMA, and WMA.
What exactly is the Exponential Moving Average?
EMA is an acronym that stands for Exponential Moving Average. It is a technical indicator tool that tracks an asset's price movement over time. It is also known as the Exponentially Weighted Moving Average (EWMA). It is important to note that this is not the same as a Simple Moving Average (SMA). A Simple Moving Average would track price movement over a set period of time. An Exponential Moving Average would track an asset's price movement in the same way, but it would give more weight to recent prices rather than treating them all equally.
The exponential moving average (EMA) is one of the oldest trading indicators and is still used by thousands of traders today. This indicator is used by day traders to help determine trend, direction, and strength. Others rely on it to determine entry and exit points.
How to Calculate EMA
There are three steps to calculating an exponential moving average (EMA). To begin, compute the simple moving average (SMA) for the initial EMA value. Because an EMA must begin somewhere, a simple moving average is used as the EMA from the previous period in the first calculation.
To calculate the SMA for the last 20 days, add the values of the last 20 closing prices and divide by 20.
Why Do Day Traders Use the Exponential Moving Average (EMA)?
The Exponential Moving Average is a popular technical indicator in the financial industry. It is most commonly used by forex and stock market traders. Traders in those markets employ the Exponential Moving Average to assist them in identifying trends in price fluctuations. Day traders frequently use multiple EMA periods to create a good setup for plotting their charts. The five, ten, twenty, and fifty-day Exponential Moving Averages are the most commonly used for identifying short-term trends.
Day Traders How Do You Use EMA?
Proper Time
The period is the first thing you need to learn in order to master the skills of moving averages. Charts on various timelines can be traded in trading. Trading can be done on one-minute charts all the way up to yearly charts.
Each of these charts necessitates a unique type of analysis.
A person who looks at annual or monthly charts is most likely a long-term investor who wants to open trades and let them run for a set period of time.
Using these charts as a day trader is pointless. As a result, long-term periods should be used by investors. The most commonly used period in this case is 200 days.
A day trader will try to enter and exit a trade within a few minutes or hours. To do so, the trader must have a short-term chart ranging from 5 minutes to 1 hour. The period used should also be brief.
Periods 12 and 24 are the most commonly used.
MAs should be combined with other indicators
Moving averages are trend indicators, which means they show a trader whether or not a trend has formed. It is critical to combine these MAs with other technical indicators in order to make informed decisions.
It will assist you in making better decisions by combining two or three indicators.
Combining MAs with volume-based indicators and oscillators is a good strategy. Personally, we believe that MAs should be combined with stochastics, the Relative Strength Index (RSI), and accumulation/distribution.
You should try to combine MAs with only a few indicators because combining them with too many will stymie your decision-making. It is also critical to consider the fundamentals of any asset you wish to buy or sell.
Economic data is released on a daily basis. You should use this data, along with the moving averages, to make sound financial decisions.
Combination of two EMAs
Another important strategy for me has been to combine two moving averages in the same chart. You combine a long-term MA (slow) and a short-term MA in this (fast).
In a 15-minute chart, for example, you could have a 14-day exponential moving average and a 5-day EMA. After that, examine the areas where the two lines intersect.
If the fast EMA crosses the slow EMA upward, this indicates a bullish chart. The opposite is also true.
Make a System
The use of a trading system is another strategy that will help you make more money with moving averages. Expert Systems, as they are known, can be extremely beneficial to you.
Creating an EA used to necessitate a strong background in statistics and computer science. Several brokers now offer a drag-and-drop platform for developing expert systems.
When developing an expert system based on moving averages, make sure your parameters are correct before incorporating them into the system (as stated above, you can combine the Mas with other indicators).
Finally, you should incorporate the system into your charts so that you can receive alerts when the points are reached. You should do a lot of backtesting before implementing it to ensure the system is accurate.
Why are moving averages useful for day trading?
Day trading is a high-speed game. You can be up and running in less than a second and then quickly give away all of your profits.
As a trader, you need a clear way to see when a stock is trending and when things have deteriorated. What better way to gauge the trend in the market than a moving average?
For starters, the indicator is literally on the chart, so you don't have to search for it elsewhere on your screen, and it's easy to understand. If the price moves in one direction over 'x' periods, the moving average will follow suit.
Unlike other indicators, which necessitate additional analysis, the moving average is straightforward and to the point. In day trading, the ability to make quick decisions without performing manual calculations can mean the difference between winning and losing money for the day.
The 10-Day Charts
Day traders like the 10-day Exponential Moving Average. Technical strategies like this have been used for centuries, but they require pinpoint accuracy to have a fighting chance of profiting from the market. It is a visual process in which the relationships between moving averages and price must be examined. It also examines moving average slopes, which reflect minor changes in short-term movement.
Increases in movement provide opportunities for day traders to buy, while decreases in movement signal a sell opportunity. When the moving average line moves sideways, it signals to the day trader that the day trading trend is weak and opportunities are limited.
The 15-Minute Charts
Day traders also use a 15-minute chart. Long-term traders should never use a 15-minute chart. As a result, the best Exponential Moving Average for a 15-minute chart should be relatively short. It makes no sense, for example, to use a 100-period EMA on a 15-minute chart. On a 15-minute chart, a 10-day period makes much more sense. This is also the best time for day traders because it gives them a good overall picture of the market.
Best EMA Strategy Exemplification
Let's create a scenario to better understand how an EMA strategy works. In this example, we'll use the best EMA strategy for day trading. The EUR/USD chart is displayed after an hourly chart that employs a 10-day Exponential Moving Average. We see an upward trend after one and a half days. This increase in upward movement provides day traders with an opportunity to buy the currency pair on pullbacks.
If we look at the 15-minute chart, we may notice some minor drops, but the price would still be on an upward trend, implying that there are buy opportunities.
What Is the Difference Between EMA and SMA?
The exponential moving average and the simple moving average are both used to measure trends. Another similarity between the two indicators is that they both use the same principles to smooth price fluctuations in a trade. However, there are some differences between the two indicators.
The EMA weights current data from a trading period more heavily, whereas the SMA calculates the average price data from the entire period.
Exponential moving average differs from simple moving average in that the EMA calculation for a given day is dependent on the EMA calculations for all previous days. To calculate a reasonably accurate 10-day EMA, you need far more than 10 days of data.
Another distinction is that, when compared to the simple moving average, the EMA is slightly more sensitive to price changes. When compared to the SMA, high sensitivity allows traders to identify a trend faster.
The advantages and disadvantages of EMA and SMA
When it comes to EMA vs. SMA, there is no better or worse. The EMA's benefits are also its drawbacks – let me explain:
The EMA reacts faster when the price changes direction, but this also makes the EMA more vulnerable to giving incorrect signals too early. For example, if price retraces lower during a rally, the EMA will immediately begin turning down, signaling a change in direction far too soon.
When there are short-term price movements and erratic behavior, the SMA moves much slower and can keep you in trades for a longer period of time. Of course, this means that the SMA enters trades later than the EMA.
EMA's Restrictions
No matter how good a trading strategy is, it can never guarantee complete success. The Exponential Moving Average still relies on past data, which can never be applied with complete confidence to the future. Past trends plotted with a moving average do not guarantee the same pattern in the future, because the future cannot be predicted. As a result, it has a rocky relationship with traders looking for leading signals. There is always the possibility of false signals with any type of moving average, such as EMAs.
Mistakes People Make When Using MAs
Entering a Trade Using Moving Average Crossovers
Many moving average traders will place a trade based on the crossing of the averages rather than the price and volume action on the chart.
For example, how many times have you heard someone say, "Well, the 5-period moving average just crossed above the 10-period moving average, so should we buy?"
This action means very little on its own. Consider this: what significance does this have for the stock? Don't you think a 5-period and 10-period moving average crossover will mean very different things for different symbols?
I recall writing simple language code for moving average crossovers in TradeStation at one point. Then I ran some backtests on a few stocks, and the results were fantastic. I was certain I had a winning system until the market reality set in.
The stocks began to trade in erratic patterns, and the two moving averages I was employing began to generate false signals. As a result, I abandoned that system in favor of the price and volume parameters discussed earlier in this article.
Avoiding the Use of Popular Moving Averages
It is impossible to succeed if popular moving averages are not used. What's the point of looking at something if you're the only one who notices it? I'm not going to go over this one again because we covered it earlier in this article.
Using Multiple Moving Averages
When working with breakouts as a day trader, you should keep the number of indicators on your monitor to a minimum. I've seen traders with up to five averages displayed on their screen at the same time.
It is preferable, in my opinion, to be a master of one moving average rather than an apprentice of all of them. If you don't believe me, consider this: in August 2010, Ben Marshall, Rochester Cahan, and Jared Cahan published a study that provided a detailed analysis of trading profits when using indicators.
Changing the Moving Averages You Use on a Regular Basis
I tried the 10-period moving average for a few weeks, then switched to the 20-period, and then I started to displace the moving averages. This period of trial and error lasted months. How do you think my results turned out in the end?
Do yourself a favor and stick to one moving average. You will gradually develop a keen sense of how to interpret the market. Remember, knowing how to read the market is more important than being correct.
Final Thoughts
The best EMA strategy for day traders is the 10-day Exponential Moving Average over an hourly chart. It provides the ideal range for a day trader to analyze the chart and forecast future price movements. However, it is important to note that EMA should never be completely relied on because nothing or no one can guarantee that something will go exactly as planned in the future. This is where good risk management comes into play to protect your account from unpredictability in price movements.
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