Just like the Simple Moving Average, Exponential Moving Average (EMA) is an indicator used to find the trend direction is a specific time, which is slightly different than the purpose of SMA in calculating the average of prices. On the other hand, EMA is biased towards recent data where it gives higher weight to current data than it gives to previous data. Accordingly, EMA has a one of a kind calculation that actually traces price movement more accurately than SMA.
Theory of operation
Mentioning that EMA is similar to SMA had a purpose, which is how it actually works. This means that analyzing the EMA data is similar to that of SMA, which is fair and square. However, EMA results are more susceptible to price movements, which actually can be both a good thing and a bad thing. The good news is that you can actually detect a trend quicker than SMA, but EMA results are also subjected to rapid changes more quickly than SMA. To use EMA wisely, make use of it in knowing the direction of the trend and plan your strategy to actually trade in the found direction. Whenever the prices are lower than the EMA, go ahead and buy. However, you are allowed to sell when the prices are just higher than the EMA. In addition, you can easily detect support and resistance zones by the presence of moving averages.
By relating the discussion of rising and falling of EMA to finding support and resistance zones we can simply infer that supporting the price movement is accompanied with a rise in the EMA and resisting the price movement is accompanied with fall in the EMA.
CALCULATION
As EMA is biased towards the current price and gives it a higher weight than that of previous prices, a direct relation between previous and current prices should be mentioned. According to the equations below, you can find that the recent price value has the highest effect on calculating EMA while the previous ones have less effect.
EMA = (K x (C – P)) + P
C = Current Price
P = Previous periods EMA
K = Exponential smoothing constant, which is the key factor here and the slight difference between EMA and SMA. This constant gives the high weight to the current price based on the number of periods in the MA.
Also see: Adaptive Moving Average MT4 Indicator
