Moving averages are important components of many technical indicators. The Exponential Moving Average (EMA) uses the closing prices of all the previous trading days for a given interval to calculate an average price from that for the period, but is weighted to give the most recent days more influence over the final number. The weighted averages are plotted in a line that helps traders follow trends.
The EMA can be closely compared to the Endpoint Moving Average (EPMA), which uses regression lines instead of averages to give recent data more weight. The EPMA uses the endpoint of the sloped regression line as the plot point for each day. Channel lines above and below the regression line can also be used as support and resistance indicators.
The EMA and EPMA are alternatives to the Simple Moving Average (SMA) line. Simple moving averages are effective in their simplicity, but their efficacy is most closely tied to how they are used. By giving equal weight to each data point, SMAs can limit bias towards any specific point in a given time period. Some traders argue that this is a negative; equal reliance on data from all points in time means an SMA does a poor job of truly reflecting a security’s most-current behavior, and its lag thus limits its predictive potential. Many traders still find ways to trade effectively with a SMA, however, especially in conjunction with other tools.
Weighting recent data more heavily means a moving average line will better fit current data. This recency bias can increase the likelihood of a trader being convinced to trade on a short-term trend and losing in a whipsaw. It is important that traders compare averages of different lengths to develop a more complete understanding of trends, as different averages can produce completely different results.
The EMA is just one of many indicators that make up technical analysis in trading. Which indicator or methodology a trader decides to use usually depends on their experience, skillset, and the quality of the tools (including artificial intelligence with Tickeron) available to help them find and verify trade ideas.