The Exponential Moving Average (EMA) line is a versatile and widely used technical indicator. It serves multiple purposes—from identifying the prevailing trend of an instrument to functioning as dynamic support or resistance. Despite its simplicity, the EMA is a powerful tool in a trader’s arsenal. In this discussion, however, we will take a more creative and analytical approach to explore how the EMA can be used to identify disparity between price and the moving average, and more importantly, how such disparity can be interpreted and applied in trading decisions.

Understanding Disparity

Disparity refers to the difference between the current market price and its average price over a given period. In technical analysis, a significant disparity is often seen as unsustainable and tends to result in mean reversion—where the price either moves closer to the average or pauses in a consolidation phase, allowing the average to catch up.

Since EMA lines represent average prices over different timeframes, they are effective tools for identifying such disparities. By using two EMA lines—one short-term and one long-term—traders can assess the extent of deviation and anticipate potential reversion or consolidation scenarios.

Identifying Disparity

Consider the concept of disparity. When does disparity occur? It arises when the price moves away from its average too rapidly within a short period. This is precisely why a short-term EMA line is used—to capture such swift movements.

When the price deviates quickly from the average, the short-term EMA tends to follow the price closely. As a result, a noticeable gap forms between the short-term and long-term EMA lines. This widening distance creates what can be visually recognized as a “bulge” between the two EMAs, indicating elevated disparity.

The best part of using EMA lines to spot disparity is that it works on charting methods such as Candlestick, Point and Figure, and Renko.

Observe the Candlestick chart below of AUROPHARMA on Daily TF. The EMA lines plotted below are 21-day (Black) and 50-day (Blue) EMA. In the chart below, the “bulge” in the EMA lines is marked as a circle. Observe how the price moved towards the 50 EMA line when the EMA lines showed bulge.

Observe the Renko chart below of BHEL on 1% (Daily) TF. The EMA lines used are 20-brick (Red) and 40-brick (Green). The “bulge” in the EMA lines is marked in circles. Observe how the price retraced towards the EMA line when the bulge was increasing.

The Point and Figure chart below is of CDSL on 1% (Daily). The EMA lines used are 10-column (Green) and 20-column (Blue) EMA lines. The bulge in the EMA lines is marked as circles and the price consolidation as a result of this bulge is shown by the arrows.

When there is a bulge in the EMA lines, should we trade contrary to the trend? The simple answer is no. This tool should be used as a tool of analysis and caution. When the bulge increases we could wait for the price to move towards the EMA line or consolidate and then trade the pullback or breakout opportunity using patterns discussed in the course on Candlestick, Point and Figure, and Renko charting method.

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If this newsletter offered you a new perspective on utilizing EMA lines, take the time to experiment with and observe this concept across different charts. Should you find it valuable, consider sharing this newsletter with your trading community.