Traders use a plethora of different moving averages to recognize trends. They also use various types like the simple moving average (SMA), exponential moving average (EMA), etc. as well as different periods of them. There was one moving average that became my favorite on a daily chart after years of swing-trading, and that’s the 20 EMA.
The 20 EMA is the best moving average for daily charts because price follows it most accurately during a trend. The price that is above the 20 can be considered as bullish and below as bearish for the current trend. Let’s have a closer look at how you can use this moving average with your swing-trades.
How to identity a trend with the 20 EMA
People usually show trends as they kept going for a long time already, but I always asked myself how I could recognize a trend early on? I don’t want to throw my money in when the trend is already extremely overextended and screams for a more significant pullback. So after digging a bit deeper and watching thousands of charts, I came up with this simple rule to confirm to myself that there is a clear trend going on in that particular stock.
Setting up rules to identify a trend
Let’s take a look at how I recognize trends early. I set up some rules to identify a trend so that I know in which direction a stock is likely going to move. You can use these rules for up- and down-trends, and they also work on different timeframes that you want to trade. So my rules are as follows:
- The price has been moving up several days with at least one higher low (or lower high if you want to trade a downtrend).
- Price has a 20 EMA that is pointing upwards, at a two o’clock angle and steeper (or a 4 o’clock angle when you are going for a downtrend).
- Price has broken resistance (or support zones in a downtrend) with substantial-high volume.
As you can see the 20 EMA is now pointing upwards and the stock is building even a second higher low. I can say that this stock is on an uptrend, and I can look for setups to create my plan and find my entry.
When we look at the price continuation of this stock, we can see that the uptrend continued significantly.
How to use the 20 EMA for swing-trades
The 20 EMA is just awesome when it comes to spotting trend reversals or even join trades when it is still trending. Since a moving average is a lagging indicator (calculation bases on past data), it can be hard to find the right entry price. That is why I always combine the 20 EMA with a support or resistance zone to create a solid plan.
Let’s what I mean by that in the following daily chart of ROKU:
As you can see in the example above the price of ROKU that the price reversed each time it has burst through the 20 EMA and a support or resistance zone with a lot of volume. Ideally, you get a gap-up-day where the price gaps over the 20 EMA and the support or resistance zone with a strong move that day. That way, you will get a high probability that the price will move in the direction of the gap.
When does it not work?
Like everything in trading, nothing works 100% of the time. You can separate price action into two different types of movement. One type is an expansion phase where the price is moving into one direction for a significant amount. The second type is a consolidation phase where the price is chopping around a support or resistance zone and where the price more or less goes sideways.
If the price goes into a consolidation phase, the price will fluctuate around the 20 EMA, and the EMA will also point to the right side horizontally.
Let’s have a look at what Micron Technology Inc. (MU) has done in such a consolidation phase:
As you can see, the price chopped around the 20 EMA until it held it as support and then went higher. If you look closer, you can see that the price has built the famous flag pattern. The flag pattern is a bullish pattern that tells us that the price will eventually move higher.
So you see it is always good if you combine moving averages with other strategies to confirm your bias and to create a more accurate plan. If you don’t know any strategy, please check our four most profitable trading setups.
Conclusion
The 20 EMA is a powerful tool on the daily chart that can yield substantial swing-trading profits. You can also use it to build up a general bias for your day-trades. Just keep in mind to always combine this moving average with other support and resistance zones.
If you want to become a better trader, consider checking out our free trading guide.