How To Trade An EMA Crossover?

Choosing the right stocks and options is no easy task. There are dozens of factors that contribute to trading decisions, beginning with investment horizon, risk tolerance, and market conditions. Beyond that, investors rely on three methods to evaluate candidates for their portfolios. 

  • Fundamental analysis examines the company, industry, and market to determine the fair value of a stock.
  • Quantitative analysis relies on financial ratio calculations to better understand the health of an organization as compared to its peers.
  • Technical analysis considers historical data in an effort to identify patterns of behavior. Once patterns are pinpointed, investors use current information to predict future trends. 

Does meticulous technical analysis lead to accurate predictions every time? No. But many investors have high success rates through the use of certain well-tested strategies.

The Exponential Moving Average Crossover (EMA Crossover) is one example of a strategy that is used frequently because it tends to deliver better-than-average results. 

Here’s what you need to know when it comes to how to trade an EMA crossover. 

What Does The EMA Tell You?

Before getting into the exponential moving average, it’s important to understand the concept of a moving average.

At its most basic, a simple moving average (SMA) combines the price high for each day during the period being measured, then divides by the number of days. For example, a five-day simple moving average would require analysts to add the high price from each of the previous five days, then divide by five. 

Trends become evident when the moving average is charted over time. On the sixth day, the first day’s high price is removed, and the new high price is used in the moving average equation. Before long, it becomes clear that the stock price is moving up, down, or staying flat.

Examining the moving average rather than relying on each day’s high point or closing price gives better visibility into true trending. Daily highs, lows, and closing prices can be impacted by outside factors, and the moving average eliminates some of that “noise.” 

The EMA looks at the same data points as a simple moving average but in a different way. Instead of a basic average in which each day’s high is given the same weight in the equation, the EMA puts more weight on recent data and less on the older data. As a result, trends can be identified more quickly with an EMA as opposed to an SMA. 

For the purpose of making trading decisions, a single EMA offers limited value. While it illuminates trends, it doesn’t show how the current trend measures up against historical trends and long-term patterns of stock behavior. That’s where an EMA Crossover strategy comes in. 

> See AAPL EMA Crossovers

What Is An EMA Crossover?

Any moving average crossover strategy, including an EMA Crossover, is designed to pinpoint a change in stock price trends. The goal is to identify how the trend is changing early enough to buy or sell in time to realize gains. 

Changes in moving averages can be spotted using crossover techniques. Moving averages for different time periods are charted, and when one line crosses over another, it could be time for action. 

For example, investors might chart a five-day EMA and a 20-day EMA. When the short-term/faster EMA line crosses over the long-term/slower EMA line, the crossover indicates a change in the trend. 

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How Do You Use The EMA Crossover Indicator?

There are two terms to be aware of when using the EMA Crossover indicator to make trading decisions: the Golden Cross and the Death Cross. When the short-term EMA crosses above the long-term EMA, it is referred to as a Golden Cross and generally a signal of an upward trend.

If there is high trading volume along with the Golden Cross, most investors feel confident that it is time to buy. 

Conversely, when the short-term EMA crosses below the long-term EMA, it is referred to as the Death Cross – that is, the stock is heading into decline. That’s generally a signal to sell, especially when there is high trading volume. 

> Best NFLX EMA Crossovers

Which Is The Best EMA Crossover?

There are endless variations on EMA crossovers. Investors can choose any combination of short and long-term EMAs to gain insight into the behavior of individual stocks and indexes, and some choose to include multiple EMAs to increase the accuracy of their predictions. 

An extraordinary amount of research has gone into answering the question, “Which is the best EMA Crossover?” In 2015, one group said they had the answer. First, they confirmed that EMA Crossover strategies are more effective than strategies that rely on simple moving averages. 

Second, they found an EMA Crossover combination that consistently delivered the best returns: buying the crossover of 13-day and 48.5-day EMAs. This generated average gains of 4.90 percent over 94 days – better than any other combination included in the study. 

With that said, this very specific EMA Crossover isn’t right for every trader and every situation. 

> AMZN Stock Price Chart

What Is The Best Setting for EMA?

EMA indicators give insight into the direction an individual stock or the larger market is moving based on how it has been moving during the period measured. It is referred to as a “lagging indicator” because it relies on data related to what has already happened. 

How EMA indicators are used depends on the investment horizon. The less time included in the EMA, the shorter the trend.

For example, traders using a scalping style are concerned with generating returns based on small price changes. They buy and sell rapidly, holding stocks for just a minute or two to increase returns through volume rather than long-term gains. They benefit most from a 5-day average since their focus is extremely short-term. 

Intraday traders also buy and sell rapidly, but they hold stocks for hours rather than minutes. A 14-day EMA is more useful under these circumstances. Short-term traders tend to rely on 21-day EMAs, medium-term traders prefer 50-day EMAs, and long-term traders focus on EMAs of 200 days or more. 

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What EMA Indicators Should I Use?

Choosing the right indicators depends on individual factors – in particular, your trading strategy. Scalping and day trading are high-pressure, high-risk methods that are best utilized by experienced investors who have the interest and ability to focus on minute movements in the market around the clock.

If you don’t plan to devote your workday to monitoring the market, a medium or long-term strategy is more appropriate. In such cases, longer-term EMA indicators offer insight into trends and patterns that will better match your timeframe. 

> MA Stock Price Chart 200 Exponential Moving Average

The Bottom Line: Is EMA Crossover Strategy Good?

When it comes to whether an EMA Crossover strategy is good, the answer is more complicated than just yes or no. The information provided by an EMA Crossover is helpful, but it isn’t a foolproof method of predicting price movements.

First, it takes experience in the market to use an EMA Crossover strategy effectively. The information can be misinterpreted, especially when used in isolation, leading to substantial losses. 

Second, it’s important to remember that all moving averages are lagging indicators. They measure events that have already occurred. By definition, the best time to buy and sell has typically passed before it is visible in an EMA Crossover.

The real objective in using this strategy is to buy or sell as close to the moment the trend changes as possible.

Finally, it is important to note that in a truly efficient market, prices already reflect any information that is available, so historical information is irrelevant to future activity. For that reason, the EMA Crossover strategy is best used in combination with other strategies to increase the accuracy of any predictions. 

The bottom line is that an EMA Crossover strategy is good, but it isn’t a perfect tool to guide trading decisions. Like any trading strategy, it is useful in making sense of a market that is ultimately impossible to predict. Using an EMA Crossover strategy in combination with other information and methods of analysis will yield the best results for building long-term wealth. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.