An exponential moving average (EMA) is a type of moving average (MA). This type of MA has a greater significance to the most recent data. Traders usually also call it as an exponentially weighted moving average.
EMA gives more significant reactions to the price fluctuation than a simple moving average (SMA) in equal weight and the same period.
Below is the formula to calculate EMA.
EMA today = (Value today∗(Smoothing / 1 + Days))+EMA yesterday∗(1−( Smoothing / 1 + Days ))
To calculate EMA, you have to calculate the simple moving average over a specific time period, first. Then, calculate the multiplier for the smoothing (weighting) with the following formula.
The multiplier for smoothing = 2 / (selected time period +1)
For example, if you want to calculate the multiplier for a 20-day moving average, then the calculation goes [2/(20+1)] = 0.0952.
After that, you can calculate the EMA with the formula above.
The Information Traders Get from EMA vs. SMA
the most popular short term averages are the 12 days- and 26 days- exponential moving average. Most traders who use technical analysis, usually find that moving averages are very useful if they use it in the right way.
Yet, if there is something wrong in the calculation, then, traders may misinterpret the information. Naturally, all types of moving averages are lagging.
Thus, the main function of moving averages should be always for checking the market move and its strength. Most of the time, once the moving averages line reflects the essential move in the market, the real market entry has passed.
Ways to Interpret the EMA
Similar to all types of MA, it is better for trending markets. During a sustained and strong uptrend, you will see the EMA indicator showing the uptrends, the same also happens during the downtrend.
Other than the direction of the line, careful traders usually will also pay attention to the rate change between the bars in the EMA.