Today, you’ll learn why is 200 EMA Important.
- Determines overall trend
- Filters trading system
- Reacts faster than the 200 MA
200 EMA is important because it determines the overall trend, filters the trading system, and reacts faster than the 200 MA.
Determining the overall trend is recommended when creating a trading strategy.
Generally, the strategy should buy in an uptrend and sell in a down trend.
It is considered 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 market changes.
The market changes when the price of security ships 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 why 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 the 200-day EMA is applied correctly, it can tell traders something.
That something can be the current trend or a change in the trend.
The current 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
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 made to follow the long-term trend.
Following the trend is always recommended because it is considered safe.
It is safe to be with the trend than to go against it.
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 over time.
For example, a 10% loss in a $10,000 position is only $1,000, while it is $2,000 in $20,000.
The increase is huge which can potentially wipe out a trading account.
To avoid being wipe out, traders can buy stocks that are going up and sell stocks that are going down.
Stocks that go up can be detected by 200-day EMA.
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.
It was not meant to be the only signal traders need.
Traders often make the mistake of relying only on this indicator.
This indicator is actually integrated by professionals in their trading system.
Trading systems need to eliminate stocks that consolidate 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 materialized.
However, traders can avoid trading losses if support and resistance are used together with 200-day EMA.
The 200-day EMA is for detecting the long-term trend before other traders even notice it.
The long-term trend direction is combined in this another strategy to reduce the risk.
- Price is above 200-day EMA
- RSI2 is below 5
- RSI is above 65
Both RSI2 and 200 EMA are combined to get high probability buy trade.
It is a high probability because the strategy was tested with Amibroker.
Amibroker can also optimize a trading strategy aside from only backtesting.
Backtesting 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 include 200 EMA to trade directional stocks.
EMA is also effective in the short-term time frames.
For example, short-term time frames are 1 hour, 30 minute, and 5 minute.
These are lower periods in which traders also use the 200 EMA.