![]() ![]() As a result of this method of calculating the average, the EMA will follow prices more closely than a corresponding SMA.Īs with all other moving average indicators, the EMA aims to use past prices to establish the direction the price of an asset is moving. However, while the SMA simply calculates an average of price data, the EMA applies more weight to data that is more current. It is similar to Simple Moving Average (SMA) in measuring trend direction over a period. The exponential moving average, also referred to as the exponentially weighted moving average, is a type of moving average indicator that places a greater weight and significance on the most recent data points. What is an exponential moving average (EMA)? We have mentioned many other methods and techniques in our article called are moving averages good or bad. There are potentially unlimited methods and ways to use an exponential moving average, and only your imagination limits you. These four strategies are, of course, not the only way to trade moving averages. The best strategy is to buy when the close crosses below the 50-day moving average and sell after 200 days. We already know that profitability increases the longer you are invested in stocks, and the tables show that. The entry into a trade is the same as in strategies 1 and 2, but we exit after N-days. The results are summarized in these two tables: ![]() Worth noting is that the max drawdown is just half of buy and hold (26 vs 56%). The 200-day moving average returns 7.84%, which is pretty decent. This is called trend-following strategies. The longer the average is, the better. The second takeaway is that the opposite strategy is more useful in the long run: The higher the number of days in the moving average the more profitable it is to buy when the close crosses above the moving average and sell when it closes below. Please keep in mind that the results don’t include reinvested dividends. The best strategy in table 1 is to use a 5-day moving average and that strategy yields a CAGR of 7.41%, which is pretty good while max drawdown is “only” 30.54%, much lower than for buy and hold. Such strategies that buy on weakness and sell on strength are called mean-reversion. This can be seen in table one: as the number of days in the exponential moving average increases, the CAGR (CAR) goes down. The first is that in the short run, it’s better to buy when the close crosses below a short-term moving average and sell when it closes above. What are the main takeaways from the two tables? The results from the two first backtest are summarized in these two tables: We use average gain per trade in percent to evaluate performance, not CAGR.
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