20 EMA Trading Strategy – Does It Work? (Rules, Setup, Backtest, Performance)

The moving averages are one of the most used technical indicators in the market. However, there are many types of moving averages. Today we are going to be looking at the exponential moving average: 20 EMA trading strategy.

The exponential moving average is a type of moving average (MA) that places a greater weight and significance on the most recent data points. But a question arises: Can it be used to develop a profitable trading strategy? 

In this article, we are going to look at what the 20-day EMA trading strategy is, backtest it, and improve it by adding an additional technical indicator.

Key takeaways

• The 20-day Exponential Moving Average (EMA) trading strategy is a technical analysis method that utilizes the 20-day EMA to generate buy and sell signals.
• This approach aims to identify short-term market swings by placing greater emphasis on recent price data. A typical application involves buying when a security’s price rises above the 20-day EMA and selling when it falls below.
• In a backtest conducted using the SPY ETF (representing the S&P 500), the strategy yielded a Compound Annual Growth Rate (CAGR) of 3.06%, underperforming the buy-and-hold CAGR of 7.87%. The strategy was active approximately 67% of the time and experienced a maximum drawdown of 42.65%, compared to a 56.47% drawdown for the buy-and-hold approach. These results suggest that, in isolation, the 20-day EMA strategy may not be particularly effective.
• However, enhancements can be made by incorporating additional technical indicators. Adjusting the strategy with supplementary tools improved performance metrics, achieving a CAGR of 5.03% while maintaining a similar drawdown. This indicates that combining the 20-day EMA with other indicators can potentially enhance trading outcomes.
• The 20ema strategy works better for crypto (Bitcoin) than for stocks, as our backtest reveals.
• In summary, while the standalone 20-day EMA trading strategy may offer limited profitability, integrating it with other technical indicators can improve its effectiveness in capturing market trends and optimizing trading performance.

What is the 20 EMA trading strategy?

The 20-day exponential moving average(EMA) strategy is a technical analysis strategy that uses the 20-day EMA to generate buy and sell signals for trading securities. It uses 20-EMA to identify short-term market swings in the price of a security. EMA gives more weight to the recent prices, which can help traders to accurately identify market swings.

Related reading:

• Looking for a good trading strategy? (Hundreds in that link)
• What Is The Best MA?
• Exponential Moving Average (EMA) strategy explained

The strategy we are going to backtest, as you are about to see, produces a purchase signal when a security’s price surpasses the 20 EMA, and triggers a sale signal when the price falls beneath the 20 EMA. This method is versatile and can be employed across various securities like forex, stocks, and commodities.

20 EMA trading strategy – trading rules

As we mentioned, the trading signal of the strategy we are going to backtest is pretty simple.

Let’s establish the trading rules:

Trading Rules

• We buy the asset when the 20-day EMA is under the asset price
• We sell the asset when the 20-day EMA is over the asset price

20 EMA trading strategy – backtest

We backtested the strategy using the ETF version of the S&P 500, SPY. The data is not adjusted for dividends and splits. Here is the equity curve:

The equity curve does not look so great. Here are some metrics and trading statistics about the strategy:

• CAGR is 3.06% (buy and hold 7.87%)
• Time spent in the market is 67.09%
• Risk-adjusted return is 4.56% (CAGR divided by time spent in the market)
• Maximum drawdown is -42.65% (-56.47%)

As you can see, the CAGR is very low despite being invested almost ~70% of the time. Moreover, the strategy experienced a significant drawdown, although not as high as buy and hold. 

On its own, the 20-EMA doesn’t seem to do well, but can we improve the strategy by adding another indicator?

20 EMA trading strategy improved

We decided to add a trading indicator to the 20-day EMA trading strategy and see whether it improved returns.

We decided to put the added trading rules behind paywall, you need to be a member to see it. Please have a look at our memberships.

The equity curve improved after we added the extra trading indicator as a filter:

Here are the statistics and performance metrics of the new strategy:

• CAGR is 5.03% (buy and hold 7.87%)
• Time spent in the market is 70.59%
• Risk-adjusted return is 7.12%
• Maximum drawdown is -42.65% (-56.47%)

For the same amount of time spent in the market, we obtained a sizable increase in performance and almost equalized the buy-and-hold CAGR on a risk-adjusted basis. Nonetheless, the drawdown remains the same.

20 EMA strategy – crypto

Moving averages tend to work better for assets that rise on momentum or are trending. One such example is cryptocurrencies. Let’s backtest the 20 EMA moving average crossover system on Bitcoin.

We make the following trading rules: we go long when the price breaks above 20 EMA, and we sell when the opposite happens. If we employ these simple two trading rules, we get the following equity curve for Bitcoin from 2014 until today:

• CAGR is 81% (buy and hold 67%)
• Time spent in the market is 56%
• Risk-adjusted return is 143%
• Maximum drawdown is -56% (-83%)

As you can see, it works much better for Bitcoin! This is expected because of the enormous momentum that Bitcoin experiences from time to time.

20 EMA trading strategy – conclusion

To sum up, today you learned what the 20 EMA trading strategy is. Although the backtest wasn’t so good, we showed you how by adding another indicator the strategy can be improved.