Moving averages is perhaps the most basic type of technical indicator you’ll be greeted with when you open your first account or learn your first course in trading. It’s popularity as a reliable signal for potential trades is perhaps due in great part to its simplicity. However, if you are to use moving averages to its fullest potential, you have to know the different types or configurations available.
Let’s first distill it down to what moving averages are in general. It goes beyond analysis of a sequence of numbers in successive order. Moving averages are more concerned about standalone time series number sets. Interest in the analysis of the interpolated data came much later alongside various lines and shaped curves. The latter was added in an attempt to predict the future location of data points.
Today, moving averages are considered a staple in the arsenal of technical analysis. Generally, simple moving averages were used prior exponential moving averages because of SMA’s easy-to-understand framework, which enabled traders to plot and track data points with relative ease. EMAs, on the other hand, adopted the SMA framework but involve other more advanced tools and functionality under the hood.
The exponential moving average underwent a series of refinements and became commonly used during the 1960s when people started conducting computer-based experiments using the indicator. The new exponential moving average was specifically designed to work on the most current prices instead of the long series of plotted data points that SMAs required.
To calculate the current EMA of a financial asset, such as binary options from TorOption, the current price is multiplied by a smoothing factor. Concurrently, the previous EMA is multiplied by 1 minus the smoothing factor. The resulting values of the two calculations are then added. The most crucial element of the formula is the smoothing constant wherein 2 is divided by 1 plus the number of days.
Once calculations are automatically made by the script contained within your trading platform, data points are plotted and a fitting line is revealed. Here, you must realize that moving averages move above or below market price and are thereby considered lagging indicators. This simply means that moving averages cannot produce real-time signals for trading binary options reliably. Once a signal is produced, the move would have already started or may even be in the midst of ending.
In general, however, a rising trend line below the binary option’s price is considered a signal to buy or go long. If it’s a falling trend line that envelops the market price, this is a signal to sell or go short. Traders use simple moving averages in an attempt to smooth out the volatile price action that’s occurred over a given time frame. Meanwhile, an EMA is employed to capture short-term price action since it is able to zone in relatively better on the most recent price action than SMA can.
An exponential moving average is effective in reducing lags so that the trend lines fit into price action in a more well-defined manner. This gives traders a better overview of what’s happening in the market thus allowing them to capitalize on any tradable opportunities that may not be so visible with the naked eye.
EMAs are also very simple compared to other technical indicators like the Ichimoku Cloud or Stochastics Oscillator. The indicator is represented by curves and lines that hug price closely and are fairly visual in nature. Picking a higher time frame, such as the 1-Hour or 4-Hour charts, make the trend line directions more reliable than, say, 1-minute or 5-minute charts.
Something that’s worthwhile noting when it comes to using EMAs is that it is prone to price breakouts particularly during volatile times in the market including weak economic output, long holidays, and mixed market sentiment. Choose specific market cycles or trading days wherein the EMA thrives in providing more reliable signals.
If you’ve open up your TorOption account, don’t be in such a hurry to trade with EMA. Look for a strategy that complements the use of EMAs. As lagging indicators, exponential moving averages work well with support and resistance lines, which are basically price levels that the market cannot seem to break out from.
If price drops below a 10-day trend line in a bullish trend, there is high probability that a bearish cycle is about to unfold and opening short positions is timely. This can also be applied to a bearish trend in the binary options market.
Exponential moving averages are a simple yet powerful tool for predicting future price action in the binary options market. Use the appropriate risk management measures with EMAs to profit consistently while capping losses.