The Exponential Moving Average differs from a Simple Moving Average both by calculation method and in the way that prices are weighted. The Exponential Moving Average (shortened to the initials EMA) is effectively a weighted moving average. The exponential moving average is considerably more complicated. The theory behind this is that more recent prices are considered to be more important than older prices, particularly as a long-term simple average (for example a 200 period) places equal weight on price data that is over 6 months old and could be thought of as slightly out-of-date.
By weighting recent price data more heavily, exponential moving averages attempt to speed up the signal given. The disadvantage of doing this, of course, is that this more-rapid signal can sometimes be premature and therefore give the swing trader a false indication to trade.
Initially, for the EMA, an exponent needs to be calculated. To start, take the number of days’ EMA that you want to calculate and add one to the number of days that you’re considering (for example for a 100 day moving average, add one to get 101 as part of the calculation).
Then, to get the Exponent, simply take the number 2 and divide it by Days+1. For example the Exponent for a 100 day moving average would be:
Which equals ~ 0.02
The basic concept is that it weights the most recent price data most heavily. The formula for the weighting of the current trading day’s value is 2 / (n+1), where “n” is the number of days in the moving average. The result of this weighting is then added to the previous exponential moving average calculation.