How to use EMA or the Exponential Moving Averages Indicator
Whether you’re a fan of indicators or you prefer a naked trading chart, I’m certain that you will be familiar with EMA’s. Moving averages have played a role in thousands of successful trading systems over the years and are certainly one of the most popular indicators for retail traders. With that being said, how useful are EMA’s? Would it be possible to use EMA’s in your trading systems? Will trading with the EMA’s get you a prop firm funded account? Well, in this article, we break down 3 of the best ways to use EMA’s to help guide your decisions in the markets and hopefully get you on the road to becoming a funded trader… Let’s get into it!
Using EMA’s In Your Prop Firm Trading Strategies
If you’ve had a rummage around any popular trading or charting platform, you’ll soon realize that there are thousands of indicators in the markets. These indicators have been created by various traders over the years to help guide trading decisions and provide some kind of edge in the forex markets. One of the most popular trading indicators that has stood the test of time is the EMA (Exponential Moving Average).
Moving averages are used in all industries to find trends and look at a set of data, over the long term. It provides valuable insight into data that otherwise would have been harder to see. This also rings true in the forex markets. There are a few very intriguing ways in which the EMA’s are used to create an edge in the markets…
Using EMA’s As A Trend Finding Tool
One of the most common uses of the EMA’s in trading is to use them to find a trend. A trend in the market is potentially a very lucrative time for traders, as typically, you’re able to generate massive risk to reward opportunities. Trending markets are where you see the markets pushing in one direction (relatively speaking) for a long period of time. This allows you to hold trades for longer and add more positions, resulting in potentially larger profits. On this GBPAUD 4H chart, you can see we have used a 200 EMA. The larger the EMA, the more accurate it should be regarding a long-term trend.
Where the market has been bearish for the long term, you can see that the price was sitting below the 200 EMA. When the market broke to the upside, the market went through a large bullish cycle, before then potentially moving back into a bearish run. It’s worth noting that this isn’t an exact science. Using EMA’s to spot trends should be used in addition to many other fundamental and technical confluences, rather than a stand-alone analysis. With that being said, many profitable algorithmic trading systems use the 200 EMA to gauge trends within the markets and follow them, along with many of our funded forex traders!
Using EMA’s As A Confluence Tool
Another great way to use the EMA’s is to look at the relationship between 2 moving averages. This is a good method to see a potential change in market sentiment or direction, somewhere near the start of a trend. The idea is elementary… When one moving average crosses below or above another moving average, we can assume that the market is changing direction. Now this will not be accurate all the time, as they can quickly change back, and during consolidation periods, you’ll see many changes of the EMA’s. However, many trading strategies can be built from the edge it provides. Taking the same GBPAUD 4H chart we used previously, by adding a 50 EMA alongside the 200 EMA, we can see how they’re both crossing as the market changed to the upside.
That, in itself, isn’t enough to trade in my opinion. But at this point, you could start looking for other fundamental and technical confluences to help build out the trade. Once you have enough confluences in the trade, you’d be able to enter a position and manage a trading opportunity. It’s worth noting that using lower value EMA’s, 20 and 50 for instance, is going to cause plenty of false crosses.
Using EMA’s As An Entry Tool
The third way to use EMA’s in your trading is to use them as an entry tool. This means that we use it as our trigger to take positions. The most typical way to do this is looking at the rejection of an EMA. As highlighted in the same GBPAUD chart, price touched and rejected the 50 EMA twice during the bearish run.
Price was already below the 200 EMA and the EMA’s had also crossed to the downside, pointing all fingers to bearish momentum. When price tapped the EMA and left high rejection wicks, if you had enough confluences, you could have entered bearish positions here. This is certainly not the most reliable way to enter a trade, though, so I’d very much recommend thoroughly backtesting this strategy before applying it in the live markets. You’d typically need to use a fairly large stop loss to make these kinds of entries work, and it’s worth noting that during consolidation periods, these entries will all be false signals.
Using EMA’s For Risk Management
My favourite way to use the EMA’s is to use them to help me manage risk within trades. I, like you, I’m certain, we all like to remove risk from trades as soon as it’s possible to do so. Frankly, I can’t relax in a swing trade until I know that my position is completely covered. With that in mind, using the EMA’s is a great way to trail your stop losses in the markets. Looking at USDJPY on the 4H chart, let’s assume that you took a sell on the break of a daily trend line retest – a popular trading strategy for retail traders.
You’d have got into the trade with a stop loss set nicely above the area we were selling from. Once price pushes down, the 200 EMA follows it, but at a safe distance. We would have easily put our stop loss on the 200 EMA and adjusted it each day this trade was open, to ensure that our stop loss was in profit and this profit was growing as the trade progressed. This form of trailing stop losses is a great way to maximise your profits in trades that run far. This is an important step to consider when building your trading plan. I would certainly recommend back testing this though as it can cause you to be stopped out of winning trades but playing it too close.
In Conclusion – Are EMA’s Helpful To Pass A Prop Firm Challenge?
In summary, EMA’s are very well suited to help you in building an edge whilst trading a funded account. I would recommend taking this with caution, however. Many traders think that indicator signals are extremely solid gauges of market direction, but this simply isn’t the case. Ultimately, indicators just take market price over X number of candles and present it differently. Price of currency is always going to be the best way to break down a market and search for opportunities, but this is much easier said than done. EMA’s are still a great way to build confidence in your trading setups.