No matter the strategy, many traders use 200 EMA as a reference. This article will delve into the 3 reasons behind the notion.
There are many different technical tools available to you in forex trading. These tools serve as a guiding hand to aid you in your market analysis. EMA is one of the most popular tools in forex trading.
In order to understand what an EMA is, we first need to understand what an MA is. In other words, we need to understand what Moving Averages are. A Moving Average is a tool used to analyze the average price over a certain period of time. It averages out prices evenly in that time period. On the other hand, EMA or Exponential Moving Averages place a more significant weightage on the current market prices rather than the past historical prices.
The Exponential Moving Average (EMA) is frequently the chosen Moving Average indicator for day traders who have an inclination to quickly execute their transactions. You may even utilize it as a solo indicator for your trading strategy.
However, you must first construct a system with which you can verify the signals in order to create a good trading formula. You may even put up two EMAs, each with its own unique period, or combine the indicator with those of other types of technical analysis.
Regarding the EMA period, the 200 EMA is one of the most popular EMAs to use in forex trading. There are several reasons why traders prefer this tool over any other. Here are the top three reasons why the 200 EMA is important:
1. Price Accuracy
The 200 EMA is able to better provide accurate price analysis, even in periods of extreme market volatility. Most technical tools don't perform well under pressure and volatile market conditions. However, the 200 EMA can focus on current and past data for accurate analysis.
2. Identify Long-Term Trends
The 200 EMA is known for its ability to identify long-term trends. This is because it is a higher EMA. The higher EMAs, like the 200 EMA, focus more on past prices and less on current market prices. That is because the line is derived from 200 past days. Compared to lower EMAs like 10 EMA which would be based on 10 previous days' data, 200 EMA is surely capable of giving a bigger picture outlook. This is why the indicator is able to identify longer market trends than shorter EMAs and is often used by long-term oriented traders.
The comparison was taken from the same currency pair in the same time frame (EUR/USD, Daily). On the left side, the picture shows that 200 EMA was consistently moving above the price during November, which indicates a bearish condition. However, the 10 EMA was moving fluctuatively during the same period, even crossing the price twice for a short period of time; this could create confusion as the movement was only based on the short-term outlook.
3. Visual Simplicity
Many different technical tools are usually really hard to interpret. They look really complicated to understand. However, the 200 EMA is a very simple tool that has a simple line display that is comparatively easier to understand than other shorter EMAs, as well as other technical tools.
The chart above describes 200 EMA as dynamic resistance on a downtrend. The way to read it is that the price would undergo a trend change once it moves across the EMA line. If the crossing happens from below the line like what is displayed on the chart, then it could be a transition from bearish to bullish.
Final Verdict
While there are several great technical tools in forex trading, there is no doubt that the 200 EMA is one of the best tools out there. As long as you're properly able to interpret the EMA lines, you should have no problem becoming a profitable trader using the 200 EMA.
There are many variations of the 200 EMA strategy, some of which combine the indicator with shorter EMA lines to get signals from the crossovers. Explore one of the combinations in How to use 50 and 200 EMA for Day Trading.