Double Exponential Moving Average

We have learned so far that the moving averages help us with entry and exit in trading. However, the persistent problem has been the slow process in most types of moving averages. To combat this situation and make the calculation of the “Moving Average methodology” faster, the Double Moving Average Method was designed.

DEMA Moving Average

DEMA, or Double Exponential Moving Average, is a moving average double indicator used in technical analysis, crafted to reduce price fluctuations and diminish the lag associated with conventional moving averages. It functions as a weighted moving average, assigning greater significance to recent price data for heightened responsiveness. The calculation involves applying a moving average exponential (EMA) to the price data and subsequently applying another EMA to the outcome of the initial calculation. This process yields a smoother and more responsive DEMA indicator compared to traditional moving averages.

How to Calculate DEMA

DEMA is a calculation of both single and double EMAs. It is a composite operation of single and double EMAs producing another EMA with less slow than either of the original two. 

Most trading analysis platforms have DEMA calculation incorporated as an indicator that can be added to charts.

DEMA serves as a restoration of the traditional (MA) methods and is generally preferred by traders due to its ability to spot reversals quicker. This helps for an early entry into a new trend formed recently.

Formula to Calculate DEMA

DEMA is computed through a two-step process involving Exponential Moving Averages (EMAs) applied to the price data, followed by subtracting the second EMA from twice the first EMA. The calculation steps and double moving average formula are outlined below:

1. Compute the Exponential Moving Average

2.  (EMA) of the price data for a defined period (N). This result is referred to as EMA1.

3. Calculate the EMA of EMA1 using the same period (N), denoted as EMA2.

4. Finally, determine the DEMA using the following formula: DEMA = 2 * EMA1 – EMA2

The choice of the period for DEMA moving average calculation varies among traders and depends on their preferred analysis timeframe, such as 20 days, 50 days, 200 days, or according to individual preferences.

How To Interpret DEMA

Interpreting the Double Exponential Moving Average (DEMA) involves understanding its signals and the insights it provides into price trends. Here's a guide on how to interpret DEMA:

1. Crossovers:

• Bullish Signal: When the DEMA line crosses above the price, it can be considered a bullish signal. This suggests a potential uptrend in the market.

• Bearish Signal: Conversely, if the DEMA line crosses below the price, it may indicate a bearish signal, suggesting a potential downtrend.

2. Trend Reversals:

• DEMA is particularly useful in identifying trend reversals. A crossover of the DEMA line with the price in the opposite direction of the prevailing trend may indicate a potential reversal.

3. Smoothing Effect:

• DEMA's double smoothing technique helps reduce noise and provides a smoother representation of price trends. This can make it easier to identify the underlying trend amid market fluctuations.

4. Confirmation with Other Indicators:

• DEMA signals are often more reliable when confirmed by other technical indicators or chart patterns. Traders commonly use DEMA in conjunction with other tools for a comprehensive analysis.

5. Divergence:

• Pay attention to divergences between the DEMA line and price movements. Divergence can signal a weakening trend or an upcoming reversal.

6. Volatility Consideration:

• DEMA is more responsive to recent price changes due to its weighted nature. High volatility may result in more frequent crossovers, so it's essential to consider the market conditions.

7. Adjusting Periods:

• Traders often experiment with different periods for calculating DEMA to suit their trading strategies. Shorter periods increase sensitivity to price changes, while longer periods provide a more stable trend indication.

Always remember that no indicator is infallible, and false signals can occur. DEMA in the stock market should be used in conjunction with other analysis tools and consider the broader market context when making trading decisions in the Indian Stock Market or any financial market.

DEMA Trading Strategy

DEMA Trading Strategy in Brief:

Indicators:

• Double Exponential Moving Average (DEMA) with short-term and long-term periods (e.g., 9-21 or 12-26).

Signals:

• Buy Signal: Look for a "Golden Cross" when the short-term DEMA crosses above the long-term DEMA, indicating a potential bullish trend.

• Sell Signal: Look for a "Death Cross" when the short-term DEMA crosses below the long-term DEMA, signalling a potential bearish trend.

Risk Management:

• Confirm DEMA signals with other indicators or chart patterns for reliability.

• Set stop-loss orders to limit potential losses.

• Consider overall market conditions and news events.

Additional Considerations:

• Monitor for divergence between price movements and DEMA.

• Experiment with different DEMA periods based on trading timeframe.

• Combine DEMA with other strategies for a comprehensive approach.

• Conduct back testing to assess historical performance.

Remember, no strategy guarantees success, and trading involves inherent risks. Stay informed, practice risk management, and adapt your strategy as needed. Only trade with capital you can afford to lose.

Advantages & Disadvantages Of DEMA

Here are some commonly acknowledged advantages and drawbacks associated with employing DEMA:

Advantages 

• DEMA offers a smoother and more responsive moving average compared to traditional simple or exponential moving averages. This results in reduced lag and more timely signals.

• DEMA effectively filters out noise and short-term fluctuations in price movements, enhancing its reliability in identifying trends and significant price changes.

• The responsiveness of DEMA makes it well-suited for volatile markets, where it can adapt more effectively to rapidly changing prices.

• For short-term traders, DEMA's ability to swiftly capture price changes and filter out noise can be advantageous for making timely trading decisions.

• When there is uneven price movement, the DEMA “removes false signals” and “refines entries” thereby creating better probabilities during strong trends.

• On a chart, it can be applied as a stand-alone indicator directly or we can integrate it into any technical indicators to resolve their values.

• The (DEMA) consists of a single Exponential Moving Average and a Moving Average Double Exponential

•  where the outcome is less slow when compared to its two individual components (EMA) & a (DEMA).

• We need to clearly understand that, it’s not just a combination of two EMAs, nor a repetition of moving average over moving average. We can define it as “A single EMA calculated in association with a double EMA”.

 

The above chart shows crude oil futures contract two different double exponential moving averages; a 50-day period appears in blue, a 21-period in yellow.

Disadvantages of DEMA

• DEMA involves more intricate calculations in comparison to simple or exponential moving averages, posing a challenge for some traders to comprehend and implement.

• Despite its design to minimize lag, DEMA may generate false signals in choppy or sideways market conditions, potentially leading to erroneous trade decisions.

• Similar to other moving averages, DEMA relies on past price data, limiting its ability to anticipate sudden market shifts or react to unforeseen news events impacting prices.

• DEMA exhibits versatility, as it can be applied to various timeframes (from intraday to long-term charts) and different asset classes, providing traders with flexibility to align with their individual trading styles.

Possible Approach of DEMA

• Add two or three DEMA’s with different trackback periods and trade their crossovers.

• DEMA can be applied as a stand-alone indicator.

• DEMA can act as a complement to other indicators used for trending markets (MACD, Parabolic SAR, etc).

Frequently Asked Questions

What Is DEMA In The Share Market?

In the share market, DEMA (Double Exponential Moving Average) is a technical indicator that provides a smoother and more responsive moving average, reducing lag and offering timely signals for traders. It is calculated by applying two successive exponential moving averages to the price data and is often used to identify trends and potential trend reversals.

What Is Exponential Moving Average?

Exponential Moving Average (EMA) is a type of moving average that gives more weight to recent prices, making it more responsive to current market conditions. It is widely used in financial analysis to identify trends and provide insights into potential price reversals.

What Is DEMA in Trading?

In trading, DEMA (Double Exponential Moving Average) is a technical indicator that enhances the responsiveness and smoothness of moving averages by applying two successive exponential moving averages to price data. It is utilized to identify trends and generate timely buy or sell signals.

How To Use Exponential Moving Average In DEMA?

To use Exponential Moving Average (EMA) in Double Exponential Moving Average (DEMA) calculations, compute the EMA for a specified period. Next, calculate a second EMA on the result. Finally, subtract the second EMA from twice the first EMA to derive the DEMA, enhancing responsiveness and trend identification in trading.

What Is the Difference Between DMA And EMA?

DMA (Double Moving Average) typically refers to a simple moving average applied twice, while EMA (Exponential Moving Average) is a type of moving average giving more weight to recent prices. DEMA (Double Exponential Moving Average) is a specific type of EMA that involves applying two EMAs for even greater responsiveness in trend analysis.