Today, you’ll learn why is 200 EMA Important.
As a general rule, 200 EMA or 200 exponential moving average is important because it determines the overall trend, filters a trading system, and reacts faster than the 200 MA.
Determining the overall trend is usually a recommendation when creating a trading strategy.
- Determines overall trend
- Filters trading system
- Reacts faster than the 200 MA
The strategy should buy in an uptrend and sell in a downtrend.
It is often an uptrend when the price is above the 200 EMA.
200 EMA is faster than its predecessor, which is the 200 SMA.
Normally, 200 SMA is slower because it does not react immediately with recent market changes.
Market change happens when the price of security moves in another direction.
Well, the price can move up for several weeks and the 200 EMA can detect it.
However, the detection of the trend is slow because EMA is a lagging indicator.
The lag is the reason professional traders don’t use 200 EMA to buy and sell stocks.
200 EMA is only used to filter uptrend or down trend stocks.
Most beginners use it as their trigger for their trades.
It is not really a trigger for people who traded stocks for a long time.
What is 200 EMA?
According to Investing.com, the 200-day EMA is a long-term trend indicator. (source)
When applied correctly, the 200-day EMA can tell traders something.
It is something which can be a trend or a change in the trend.
The trend can be up or down, which does not create a profitable signal.
It does not create profitable signals because the signals are always late.
Because it is late, professional traders only use it as a filter.
Determines overall trend (Daily Chart)
200-day EMA indicator determines the overall market trend.
For example, the overall market trend is up if the price of the security is above the indicator line.
If the price is above 200 EMA, traders often make only buy trades.
Buy trades are usually reliable in this market environment used for following the long-term trend.
Following the trend is important because it is safer, because it is not against the direction of the main trend.
It is usually safe to be with a trend than to go against it and what is important is being early.
When traders go against a trend, averaging down or up their stock positions is common.
Averaging down is not really a good idea because the risk is going to be bigger.
For example, a 10% loss in a $10,000 position is only $1,000, while it is $2,000 in $20,000.
The increase would be huge, which might wipe out a trading account.
To avoid being wiped out, traders can buy stocks that are going up and sell stocks that are going down.
The 200-day EMA can detect stocks that are going up.
Filters trading system
Quant traders often use the 200 EMA indicator to filter uptrend stocks.
For example, To get uptrend stocks, Larry Connors uses this indicator together with his cumulative RSI strategy. (video)
The RSI strategy filters uptrend stock using this EMA indicator.
The main trigger to buy the stock is when the RSI is equal to five on a two-period cumulative RSI.
Of course, the cumulative RSI trigger must also be in an uptrend.
Uptrend means the stock is going up.
To scan stocks that are going up, Mark Minervini also use the 200 day period. (source)
The 200-day EMA is important in filtering uptrend or down trend stocks.
Traders often make the mistake of relying only on this indicator.
Professionals in their trading system actually integrated this indicator.
Trading systems need to eliminate stocks that are not expanding because those stocks have high volatility.
Volatile stocks are high risk, especially to beginners.
Beginners can use 200 EMA in their trading strategies to avoid selling in an uptrend.
Reacts faster than the 200 MA
200-day EMA is faster than the Simple Moving Average Indicator. It is faster and traders can use EMA signals to find trends early.
Although the signals are early, the trader can be susceptible to fake outs.
A fake out is trend signal that does not continue or mature.
In short, the trader will lose money because the trend did not materialize.
However, traders can avoid trading losses if they use together support and resistance with 200-day EMA.
The 200-day EMA is for detecting the long-term trend before other traders even notice it.
A note on EMA Crossover
200 EMA crossover is usually not a reliable indicator of technical analysis when used alone. For example, when the 20 EMA crosses over the 200 EMA, it does not signal a high probable trade because all moving average indicators are usually lagging the markets.
It means the signals are too late, which is not useful in short-term trading.
200 EMA is usually an essential filter for trading any securities, which can complement other technical indicators, such as MACD, stochastic, and Relative Strength Index.
200 EMA Trading Strategy: With RSI 2(Trading Signals)
The long-term trend direction is an integral of this another strategy to reduce the risk.
This trading strategy applies to the daily timeframe.
Buy or entry signal:
- Price is above 200-day EMA Line
- RSI2 is below 5integral
- RSI is above 65
It combined both RSI2 and 200 EMA indicator to get a high probability trading signal, for example, for day trading.
It is a high probability because the strategy is profitable when tested with Amibroker.
Amibroker can also optimize a trading strategy aside from only back-testing.
Back-testing is a way to validate a trading strategy.
A trading strategy should include a filter to find trending stocks.
The filter used by most system traders often includes 200 EMA to trade directional stocks.
EMA is also effective in the short-term time frames.
For example, short-term time frames are one hour, 30 minutes, and five minutes.
These are lower periods in which traders also use the 200 EMA.
Did you learn something about our post, “200 EMA?” Please share it.