What is the Double Exponential Moving Average (DEMA)?

What is the Double Exponential Moving Average (DEMA)?

Double exponential moving averages (DEMA) are an improvement over Exponential Moving Average (EMA) because they allocate more weight to recent data points. The reduced lag results in a more responsive moving average, which helps short-term traders spot trend reversals quickly.

Let us look at Apple Inc.’s prices over a period of nine months from April to November 2020. The chart uses candlesticks, which are used to reflect the change in Apple’s stock price for each period.

The yellow line is the simple moving average line. The red line indicates exponential moving average (EMA), and the green one is the DEMA line. We can observe that the DEMA is closest to the price points and with the least deviations.

Calculating a Double exponential moving averages

As Mulloy explains in his original article, “the DEMA is not just a double EMA with twice the lag time of a single EMA, but is a composite implementation of single and double EMAs producing another EMA with less lag than either of the original two.” In other words, the DEMA is not simply two EMAs combined, or a moving average of a moving average, but it is a calculation of both single and double EMAs.

Nearly all trading analysis platforms have the DEMA included as an indicator that can be added to charts. Therefore, traders can use the DEMA without knowing the math behind the calculations and without having to write or input any code.

Scanning for Double exponential moving averages

StockCharts members can screen for stocks based on DEMA values. Below are some example scans that can be used for DEMA-based signals. Simply copy the scan text and paste it into the Scan Criteria box in the Advanced Scan Workbench.

See also :  What is a Stockbroker?

Members can also set up alerts to notify them when a DEMA-based signal is triggered for a stock. Alerts use the same syntax as scans, so the sample scans below can be used as a starting point for setting up alerts as well. Simply copy the scan text and paste it into the Alert Criteria box in the Technical Alert Workbench.

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.

Trading With a Double Exponential Moving Average

The above moving average crossover examples illustrate the effectiveness of using the faster DEMA. In addition to using the DEMA as a standalone indicator or in a crossover setup, the DEMA can be used in a variety of indicators in which the logic is based on a moving average.

Technical analysis tools such as moving average convergence divergence (MACD) and triple exponential moving average (TRIX) are based on moving average types and can be modified to incorporate a DEMA in place of other more traditional types of moving averages.

Substituting the DEMA can help traders spot different buying and selling opportunities that are ahead of those provided by the MAs or EMAs traditionally used in these indicators. Of course, getting into a trend sooner rather than later typically leads to higher profits.

See also :  What is the Modern Portfolio Theory (MPT)?

Figure 2 illustrates this principle—if we were to use the crossovers as buy and sell signals, we would enter the trades significantly earlier when using the DEMA crossover as opposed to the MA crossover.

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.

Leave a Comment