What Is a Double Exponential Moving Average (DEMA)?
The double exponential moving average (DEMA) is a technical indicator that was devised to reduce the lag in the results produced by a traditional moving average. Technical traders use it to lessen the amount of "noise" that can distort the movements on a price chart.
Like any moving average, the DEMA is used to indicate the trend in the price of a stock or other asset. By tracking its price over time, the trader can spot an uptrend, when the price moves above its average, or a downtrend, when the price moves below its average. When the price crosses the average, it may signal a sustained change in the trend.
This variation on the moving average was introduced by Patrick Mulloy in a 1994 article "Smoothing Data With Faster Moving Averages" in Technical Analysis of Stocks & Commodities magazine.
- The double exponential moving average (DEMA) is a variation on a technical indicator that is used to identify a potential uptrend or downtrend in the price of a stock or other asset.
- A moving average tracks the average price of an asset over a period of time in order to spot the point at which it establishes a new trend, moving above or below its average price.
- Some traders see a flaw in the standard moving average: It has a lag time that increases with the length of the time period being charted.
- The DEMA addresses this flaw, reducing lag time in the indicator.
- The DEMA, therefore, has a stronger filter for the "noise" of irrelevant market action that can distort charted results.
The Formula for the Double Exponential Moving Average Is:
DEMA=2×EMAN − EMA of EMANwhere:
How to Calculate the Double Exponential Moving Average
There are just four steps to this calculation:
- Choose any lookback period, such as five periods, 15 periods, or 100 periods.
- Calculate the EMA for that period. This is EMA(n).
- Apply an EMA with the same lookback period to EMA(n). This produces a smoothed EMA.
- Multiply two times the EMA(n) and subtract the smoothed EMA.
What Does the Double Exponential Moving Average Tell You?
Although the indicator is called a double exponential moving average, the equation does not rely on using a double exponential smoothing factor. Instead, the equation doubles the EMA, but then cancels out the lag by subtracting a smoothed EMA.
Because of the complication of the equation, DEMA calculations require more data than straight exponential moving average (EMA) calculations. However, spreadsheets and technical charting software can easily calculate DEMAs.
The DEMA is used most often by day traders and swing traders. Long-term investors may be better off using a standard moving average.
Who Uses DEMAs and Why
DEMAs react quicker than traditional moving averages, so their users are more likely to be day traders or swing traders. Long-term investors, who trade less frequently, may find that a traditional moving average works better for them.
DEMAs are used primarily to spot an upward or downward trend in price and analyze its strength. Traders watch for a price to move above or below the DEMA. Some use multiple DEMAs with different lookback periods, watching for the DEMAs to cross each other.
Like any moving average, a DEMA also can be used to indicate price support or resistance. That is, it can help identify the price point at which a trend will pause or even reverse.
How to Read the DEMA
Reading the DEMA is straightforward. When the price of an asset is above the DEMA, and the DEMA is rising, it helps confirm an uptrend in price. When the price is below the DEMA, and the DEMA is falling, that helps confirm a downtrend.
As noted above, some traders display two or more DEMAs with different look-back periods on a single chart. Trade signals could be generated when these lines cross.
For example, a trader may buy if a 20-period DEMA crosses above a 50-period DEMA, or sell when the 20-period crosses back below the 50-period.
The DEMA may be less reliable when used to indicate potential support and resistance price points. A trader viewing a DEMA, or any moving average, to pinpoint potential support or resistance points should make sure that it has served this function in the past. If not, it likely won't in the future.
Double Exponential Moving Average (DEMA) and the Triple Exponential Moving Average (TEMA)
As the names imply, the double EMA includes the EMA of an EMA. The triple EMA (TEMA) has an even more complex calculation, involving an EMA of an EMA of an EMA.
The goal is still to reduce lag, and the triple EMA has even less lag than the double EMA.
A DEMA, or any moving average, will likely be more reliable if a longer period of time is selected for tracking. Time diminishes the effects of "noise" in the markets.
Limitations of the Double Exponential Moving Average
Moving averages can provide little or no insight during times when the price of an asset is choppy or range-bound. No reliable trend can be identified at such times. The price will frequently cross back and forth across the DEMA.
In addition, the strength of the DEMA is its ability to reduce lag, but that can be its weakness in some circumstances.
The reduced lag gets the trader out quicker, reducing losses. Yet reduced lag can also encourage overtrading by providing too many signals. The indicator may tell a trader to sell when the price makes a minor move, thus missing out on a greater opportunity if the trend continues.
The DEMA is best used in conjunction with other forms of analysis, such as price action analysis and fundamental analysis.
What Is the Difference Between a Simple Moving Average and DEMA?
The double exponential moving average may be best described as a "smoothed" simple moving average.
A standard moving average displays a lag time that increases with the amount of time being charted. The double exponential moving average seeks to shorten that lag time to a consistent level.
Overall, it gives the trader an earlier warning of a change in the direction of an asset's price.
What Is the Most Accurate Moving Average?
The accuracy of a moving average depends in great part on the length of the time period being tracked. The most commonly used moving average periods are 50-day, 100-day, and 200-day moving averages.
Historically speaking, the longer the term the more accurate the indicator. This is because the day-to-day "noise" of the markets diminishes in impact over time. It takes time for a trend to clarify.
How Do You Use a Double Exponential Moving Average?
The double exponential moving average, like any moving average, is designed to trigger a buy or sell signal based on the price movements over time of a given asset. The signal is triggered by a sustained change upwards or downwards of the asset's price.
What Is MACD DEMA?
The moving average convergence/divergence (MACD) is an indicator that seeks to add greater insight to the moving average by determining the relative momentum of the price movement. The MACD is calculated by subtracting the 26-period EMA from the 12-period EMA.
The result may help a trader determine whether a price trend appears to be gaining or losing strength.
Some traders use MACD in combination with the DEMA rather than with a standard moving average.