What is a Double Exponential Moving Average (DEMA)?
The Double Exponential Moving Average is a technical indicator introduced by Patrick Mulloy in his January 1994 article "Smoothing Data With Faster Moving Averages" in Technical Analysis of Stocks & Commodities magazine.
The DEMA uses two exponential moving averages (EMAs) to eliminate lag, as some traders view lag as a problem. The DEMA is used in a similar way to traditional moving averages (MA). The average helps confirm uptrends when the price is above the average, and helps confirm downtrends when the price is below the average. When the price crosses the average that may signal a trend change. Moving averages are also used to indicate areas of support or resistance.
- The DEMA responds quicker to price changes than a normal exponential moving average (EMA).
- The DEMA can be used in the same way as other MAs, as long as the trader understands the indicator will react quicker than traditional MAs. This may require some alteration of strategies.
- Less lag isn't always a good thing because lag helps filter out noise. An indicator with less lag is more prone to reacting to noise or small inconsequential price moves.
- A longer-term time frame DEMA, like 100 periods, will be slower to react than a shorter-term time frame DEMA, like 20 periods.
The Formula for the Double Exponential Moving Average (DEMA) is
n = look-back period
How to Calculate the Double Exponential Moving Average (DEMA)
- 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 gives a smoothed EMA.
- Multiply two times the EMA(n) and subtract the smoothed EMA.
What Does the Double Exponential Moving Average (DEMA) 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 subtracted a smoothed EMA. Because of the complication of the equation, DEMA calculations require more data versus straight EMA calculations. However, modern spreadsheets and technical-charting packages easily calculate DEMAs.
DEMAs react quicker than traditional MAs, which means they are more likely to be used by day traders and swing traders. Investors may also use them, but since many long-term investors prefer to be less active in the assets they hold traditional MAs may work better.
DEMAs are used in the same ways as traditional MAs. DEMAs can also be used to analyze the strength of an uptrend or downtrend in price. Traders may watch for price to cross the DEMA, or DEMAs to cross each other if using multiple DEMAs (with different lookback periods). The DEMA may also provide support or resistance.
Mainly, traders watch price relative to the DEMA to assess the trend direction and trend strength. When the price is above the DEMA, and the DEMA is rising, it helps confirm an uptrend. When the price is below the DEMA, and the DEMA is falling, that helps confirm a downtrend.
Based on the above, if the price moves above the DEMA from below that could signal the downtrend is over and the price is starting to rise. If the price drops below the DEMA from above, that could signal the uptrend is over and lower prices are forthcoming.
Traders could also two (or more) DEMAs with different look-back periods on their chart. Trade signals could be generated when these lines cross. For example, a trader may buy when a 20-period DEMA crosses above a 50-period DEMA. They would sell when the 20-period crosses back below the 50-period. This is a simplified example, but a DEMA crossover is another tactic traders can use.
Finally, traders can use the DEMA to mark potential support and resistance areas. Since the DEMA reacts quickly, this may not always be effective. If viewing a DEMA, or any moving average, as potential support or resistance, it is important to make sure that the MA has actually provided support or resistance in the past. If the MA has not served this function in the past, it likely won't in the future.
The Difference Between the 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 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.
Limitations of the Double Exponential Moving Average (DEMA)
Moving averages tend to work well in trending markets, but provide little insight when the price is choppy or range-bound. During such times the price will frequently cross back and forth across the MA or DEMA. The short-lived price moves are unlikely to result in profitable trade signals.
Reducing lag can be good in some circumstances, like when an actual price reversal occurs. The reduced lag gets the trader out quicker, reducing their losses. Yet reduced lag can also result in overtrading. This is when an indicator provides too many signals. For example, the indicator tells a trader to sell when the price makes only a minor move against them. The trader sells only to watch the price continue in their original direction. Sometimes lag is good, and sometimes it isn't. It depends on what the trader wants from an indicator. It is up to the trader to find a balance, and determine how much lag works for them.
The DEMA is best used in conjunction with other forms of analysis, such as price action analysis, fundamental analysis, and other technical indicators.