Double Exponential Moving Averages Explained

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Double Exponential Moving Averages Explained

What Is a Double Exponential Moving Average?

For many years, traders have depended on moving averages to assist them identify high probability trading entry positions and winning exits. A well-known issue with moving averages is the significant lag that is inherent in most forms of moving averages. By computing a quicker averaging process, the double exponential moving average, or DEMA, gives a solution.

In technical analysis, a moving average is a price average for a certain trading instrument over a given time period. A 10-day moving average, for example, computes the average price of a certain instrument over the previous 10 days; a 200-day moving average computes the average price over the previous 200 days; and so on. The look-back time increases each day, allowing computations to be based on the past X days.

Key Takeaways

  • A moving average is a price average for a certain trading instrument over a given time period.
  • The 10-day, 20-day, 50-day, 100-day, and 200-day moving averages are the most often used by traders and investors.
  • Another useful indicator is the double exponential moving average (DEMA), which lowers lag time.
  • Moving average indicators are available on almost all trading platforms and may be applied to charts.

History of the Double Exponential Moving Average

A moving average is a smooth, curved line that offers a visual picture of an instrument’s longer-term trend. Slower moving averages with longer look-back intervals are smoother than faster moving averages with shorter look-back periods. A moving average is referred to be lagging since it is a backward-looking indicator.

Patrick Mulloy created the double exponential moving average (DEMA) in an effort to lessen the amount of lag time inherent in regular moving averages. Mulloy’s essay “Smoothing Data with Faster Moving Averages” initially appeared in the February 1994 edition of Technical Analysis of Stocks & Commodities.

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Figure 1: This one-minute chart of the e-mini Russell 2000 futures contract shows two different double exponential moving averages; a 55-period appears in blue, a 21-period in pink.

Image by Sabrina Jiang © Investopedia2021

Calculating a DEMA

“The DEMA is not merely a double EMA with twice the lag time of a single EMA,” Mulloy says in his original essay, “but rather a composite implementation of single and double EMAs generating another EMA with less lag than either of the original two.” In other words, the DEMA is a computation of both single and double EMAs, rather than merely two EMAs combined or a moving average of a moving average.

The DEMA is an indicator that can be applied to charts in almost all trade analysis programs. As a result, traders may utilize the DEMA without understanding the arithmetic or having to develop or enter any code.

Comparing the DEMAWith Traditional Moving Averages

Moving averages are one of the most often used technical analysis techniques. Many traders use them to detect trend reversals, particularly when two moving averages of differing durations are superimposed on a chart. Crossing points between moving averages might indicate buying or selling opportunities.

Because it responds to changes in market activity more quickly, the DEMA may help traders notice reversals sooner. Figure 2 depicts an e-mini Russell 2000 futures contract. Four moving averages have been applied to this one-minute chart:

  • 21-period DEMA (pink)
  • 55-period DEMA (dark blue)
  • 21-period MA (light blue)
  • 55-period MA (light green)

Figure 2: This one-minute chart of the e-mini Russell 2000 futures contract illustrates the faster response time of the DEMA when used in a crossover. Notice how the DEMA crossover in both instances appears significantly sooner than the MA crossovers.
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Image by Sabrina Jiang © Investopedia2021

With 12:29, the first DEMA crossover occurs, and the following bar opens at a price of $663.20. The MA crossover, on the other hand, occurs at 12:34, and the starting price of the following bar is $660.50. The DEMA crossover occurs at 1:33 in the following series of crossovers, and the next bar opens at $658. In contrast, the MA develops at 1:43, with the following bar opening at $662.90. In each case, the DEMA crossover gives an advantage in entering the trend before the MA crossover.

Trading With a DEMA

The moving average crossover examples shown above demonstrate the efficacy of employing the faster DEMA. The DEMA may be utilized in a number of indications that employ moving average logic, in addition to being used as a solo indicator or in a crossover arrangement. Moving average convergence divergence (MACD) and triple exponential moving average (TRIX) are technical analysis techniques that may be adapted to include a DEMA instead of other more standard forms of moving averages.

By using the DEMA instead of the MAs or EMAs that are often employed in these indicators, traders may identify distinct buying and selling chances that are ahead of those supplied by the MAs or EMAs. Of course, jumping on a trend sooner rather than later usually results in bigger earnings. Figure 2 shows this principle: if we were to utilize crossovers as buy and sell signals, we would start trades much sooner if we used the DEMA crossover rather than the MA crossover.

The Bottom Line

Moving averages have long been utilized in market research by traders and investors. Moving averages are a popular technical analysis technique for swiftly analyzing and understanding the longer-term trend of a trading instrument.

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Because moving averages are lagging indicators by definition, it is beneficial to alter the moving average in order to produce a faster, more responsive indication. The DEMA gives traders and investors a sense of the longer-term trend while also having a quicker moving average with less lag time.

Investopedia does not provide tax, investment, or financial advice. The material is offered without regard for any individual investor’s investing goals, risk tolerance, or financial circumstances, and may not be appropriate for all investors. Investing entails risk, including the possibility of losing money.

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