Exponential Moving Average (EMA) is applied in Forex and is one of the sorts of simple moving average. Exponential Moving Average represents one of the cases of weighted moving average, because not only price values, but weight values as well as are used in its measurement. The difference between them is that price for entire period of observation are accounted, whereas weight is exponentially decreased and is never equal to 0, thereby assigning more weight to new prices. Upon that, exponential smoothing formula is used rather than linear arithmetical or another progression. This exponential smoothing is applied in forecasting number series.
Forex EMA is calculated as per the formula:
EMAt – EMA in the point corresponding to a certain moment of time;
EMAt-1 – EMA in the point preceding preset moment of time;
pt – source value of price on chart corresponding to a certain moment of time;
α – smoothing constant – designates speed of reducing weight, by default it takes 0<α<1 .
In order words, to calculate Exponential Moving Average in Forex, a previous price value is taken multiplied into smoothing constant and added to previous price value. This way, the more α value is, the less impact on current EMA value is asserted by the previous figure. As a rule, the constant equal to 2/3 is taken.
As with other kinds of MA, various prices can be taken into account: Close, Open, High, Low, Median Price, Typical Price, Weighted Close.
When it comes to EMA of arbitrary Forex order, as a rule, two special cases are distinguished: double exponential moving average and triple exponential moving average. The order sets smoothing extent of price: the higher order is, the stronger smoothing gets. Upon that, EMA value is smoothed rather that initial price pt.
In this case, the formula looks as below:
Application of EMA in Forex
Exponential Moving Average is applied in the same way as any type of moving average: for defining entrance and exit signals. However, EMA represents the line, which is rougher to initial chart and allows to get more precise signals quicker that, for example, SMA – simple moving average (watch picture 1) It has a special importance, at the moments of publication of important economic news, large interventions and other similar cases, when prices promptly change.
It is better to apply EMA in short-term trading, because it responses to Forex changes with a maximum speed and is not as demonstrative on high time-frames. You can find out that on pic 1 (daily chart) EMA line is more smoothed than on pic. 2 (5-min time-frame)
Picture 1 Simple and Exponential Moving Average with period 21
Picture 2. Exponential Moving Average with period 21, 5-min time-frame