What is a Displaced Moving Average (DMA)?
A displaced moving average (DMA) is a moving average (MA) that has been adjusted forward or back in time in an attempt to better forecast trends or better fit the price movements of an asset. An MA can be displaced forward on a chart, which is called positive displacement and will move the MA to the right. It can also be displaced back in time, called negative displacement, and that will move the MA to the left.
- A DMA is any MA that has all its values shifted forward or back in time.
- The amount of displacement depends on the asset being traded, and the investor's desires. Investors displace a moving average so that it better aligns with highs or lows in price, and better contains or fits the price.
- A displaced moving average is used in the same way as a traditional MA. It helps determine trend direction and reversals, may provide trade signals, and helps forecast potential support and resistance areas.
How to Calculate a Displaced Moving Average (DMA)
The DMA doesn't require any calculation beyond the moving average calculation. Each value of the MA is moved forward or backward by the number of periods determined by the trader.
For example, assume a trader wants to displace their MA three periods into the future. The current MA value will be placed three periods into the future on the chart. The prior period's value will also be placed three periods into the future, and so on.
Most charting software does this automatically. When applying a moving average, the settings will often ask for how much displacement is desired. Alternatively, there may be a separate displaced MA indicator with this setting.
What Does the Displaced Moving Average (DMA) Tell You?
The DMA does all the things a normal moving average does, but in some cases, it may do it better because it can be better tailor to the asset being traded.
In general, the DMA helps determine trend direction. When the price is above the MA that helps indicate an uptrend, or at least that the price is above the average. When the price is below the MA, the price is below average which is one sign of a downtrend.
When the price moves through the MA that could signal the trend is changing. If the price falls through the MA from above, that could signal the uptrend is over and a downtrend is starting.
How the MA is displaced can aid in providing better reversal signals. Assume that in the past the uptrending price has just slightly dropped below the MA only to rally once again shortly after. In this case, the price dropping below the MA wasn't a reversal signal, the MA just didn't fit the price action well. Displacing the MA by several periods may help keep the price above the MA, creating a better fit for the asset's trend and thus avoiding some of the false signals.
Another option in the above scenario is to alter the lookback period of the average (how many periods it is calculating an average for). This too may result in the MA better fitting the price data. Increasing the lookback period typically results in the MA having more lag, as it is slower to react to price changes since recent price changes have less of an impact on a larger average. Therefore, displacement is an option when a trader wants the MA to better align with the price but doesn't want to increase lag.
A moving average can also help identify support and resistance. As discussed above, during an uptrend the MA can be aligned with price so that historical pullback lows align with the MA. When the price approaches the MA the trader knows that the MA may provide support. If the price stalls at the MA and starts to rise again, a long trade can be taken with a stop loss below the recent low or below the MA.
The same concept applies to downtrends. The displaced moving average is adjusted to align with the pullback highs during the downtrend. On future pullbacks, the trader can watch to see if the DMA still provides resistance. If it does, that may provide a short trade opportunity.
The Difference Between a Displaced Moving Average (DMA) and Exponential Moving Average (EMA)
An exponential moving average is a type of MA that reacts quicker to price changes than a simple MA. This is the result of a more complex calculation that puts more weight on recent price values. A DMA is any MA that is moved forward or back in time. While simple MAs are often used for displacement, an EMA can be displaced as well. This involves moving the EMA values forward or backward in time.
Limitations of Using a Displaced Moving Average (DMA)
An MA is the average price of an asset over a period of time. It does not inherently have any predictive calculations factored into it. Therefore, any MA, including a displaced one, won't always provide reliable information for trend reversals or support/resistance levels.
Moving averages in general, including displaced ones, tend to provide better information during trending markets, but provide little information when the price is choppy or moving sideways. During such times the price will move back and forth across the MA, but since the price is moving sideways overall the crossovers aren't likely to generate highly profitable trading opportunities and may result in losses.
Reversal, support, and resistance signals may not always work. The price may move through an MA only to move back in the original direction. While the MA may have provided support or resistance in the past, it may not in the future.