The EMA Cloud: The Next Generation Of Indicators?

As I have talked about countless times on here, having an edge in the market is directly correlated to having something unique that is not public, that no one else uses. It's always about thinking outside the box and doing things just differently enough that give you that trading edge over everyone else. In this article, we are going to discuss how a trader just did that, thinking outside the box, made things a bit different than they were before, and was able to use this new strategy to become profitable.

EMA Clouds is one of the newest and most effective indicators out there, which was recently developed and pioneered by Ripster. The EMA Cloud System takes two desired EMAs. The area in between is shaded to visually represent the trend direction and determines the support and resistance levels. Take a look at the EMA Cloud Chart above using a real-life example of $SPY.

Notice how the 20 EMA is above the 50 EMA, this yields a green (bullish cloud), which then provides support for the price as it falls through the cloud. In this case, it's highly likely price will bounce off the cloud and continue higher, which is exactly what happened

For those astute traders, you will notice that the EMA Clouds are very similar to the Ichimoku Cloud System. So what Ripster did, was inspired by Ichimoku Clouds, used his own critical thinking, and innovated.

How to use the EMA Cloud Indicator

The idea behind the indicator is that the EMA cloud area represents support/resistance. This system can be profitably applied to any sort of time frame (day trading, swing trading, etc). It's essentially a momentum indicator, predicting when prices will bounce.

Many different combinations can be applied via the Cloud system. it is very important to figure out what works best for you and your style. EMA Settings of 5-12, 34-50, 8-9, and 20-22 are typically used, where the first number represents one EMA, and the 2nd part will be a higher number representing the 2nd EMA, where the shaded region between the two become the cloud. I suggest tinkering with these settings and seeing what else is out there.

According to Ripster, the ideal combination that creates a fluid trendline for day trades is 5-12 or 5-13 EMA cloud while the pullback levels can be identified by the use of 8-9 EMA cloud. 

 A bullish/bearish trend is confirmed when the price is over/under 34-50 EMA clouds for any set timeframe. 

Here you can see where the 34 EMA is below the 50 EMA (34-50 setting), it's portrayed as a red cloud, and the cloud starts to act as resistance

Ideally, your setup will include many EMA clouds on your chart, where the 34/50 EMA will be your long-term trend direction, and the other smaller clouds will be your bounce, add, and sell targets. So your chart will essentially look like a rainbow EMA cloud, see below:

Step by Step guide on using EMA Cloud

1. Look for the indicator on your preferred trading system, such as TrendSpider (click the link for 25% off using code CL25!). Be warned as new as this indicator is, it’s unlikely it will show up on many platforms out there. Make sure to google to confirm. Currently, I believe it's only on TrendSpider as well as TradingView (script for EMA Cloud linked).
2. Add your preferred set of moving average types, the commonly used being the exponential moving average. One long-term (i.e. 34-50) and the other short-term (i.e. 8-9). (If using TrendSpider it is recommended you use the backtesting tool to find what EMA settings are most profitable)
3. Much like Ichimoku Clouds, you can set the Cloud forward and backward in time using the Offset entry. The setting of zero will keep the EMA's current with respect to price, but values such as 5 will move the Cloud (forward).  Again it is important to tweak these settings and see if you can make things more profitable. Some prefer having an offset to move the Cloud from previous days further/backward as they think it may give better accuracy. This is something you will want to test.

Chart Interpretation

When the short-period EMA graph line goes above the long-term EMA trend line (thus turning green), this is a bullish signal while vice versa when the market is bearish.

So keep a note at inflection points where a red cloud turns green, and vice versa! These are buying & selling signals. However, be careful being whipsawed, make sure the settings you have, can withstand false signals where the cloud turns colors too easily giving you bad signals.

Here is another example of how SPY continually bounces off the cloud over a long period. Note this is a daily chart of the 20/50 EMAs:

Additionally, check out the chart below straight from Ripster47's Twitter account, where he gives an example with annotations with the EMA Cloud using a one-minute chart with Apple ($AAPL).  He's using the 34/50 EMA Cloud, where, the stock turned from bearish, to bullish, followed by a nice bounce, where following the cloud would have made all aspects of the trade profitable:

Conclusion

The EMA Cloud is one of those rare indicators that come out, that has a fresh take on stagnant technical indicators that have been out there for decades. It is strongly advised, that traders pay attention to this indicator and backtest it to see its strengths and weakness. I highly recommend signing up for TrendSpider (use my link for 25% off) and testing it out with their backtesting tool. Make sure to tweak the settings, and see how you can make it better.

Also, try adding additional indicators to come up with a cluster of signals, and see how you can make this more profitable and uniquely your own.

For those still struggling to get that elusive stock trading edge check out our step-by-step guide on how to create one. Additionally, for those who want to use TrendSpider, I have given a step-by-step tutorial on how to create a stock trading system.

Finally, for those seriously eager-to-learn traders wanting to know more about EMAs as they are used in EMA Clouds, check out our EMA vs SMA indicator article.

Also, looking for more innovative indicators? Check out our article on RainDrop Charts which incorporates volume into chart reading to help avoid fake breakouts.