When we talk about technical indicators, the most commonly used indicators include the RSI indicators, MACD, Moving Averages, Oscillators, and more. These indicators help in understanding the price and volume movements of a stock or security to make effective trading decisions. Moving Averages are further analysed using the concepts of simple moving averages (SMA) or exponential moving averages (EMA) and DEMA is a step further in fine-tuning this understanding of stock movements. Check out this blog to learn more about Double Exponential Moving Average (DEMA) and its uses in creating a successful trading portfolio.
Read More: Top 5 technical analysis tools for the stock market
What is the meaning of the DEMA indicator?
The term DEMA stands for Double Exponential Moving Average. It is a technical analysis indicator that is designed to minimize price fluctuations and decrease the delay present in traditional moving averages. DEMA is a weighted moving average that gives higher importance to recent prices, making it more responsive. To calculate DEMA, an exponential moving average (EMA) is applied to the price data, and then another EMA is applied to the result of the first one, resulting in a smoother and more reactive indicator.
What is the formula to calculate DEMA?
DEMA is derived by applying two successive EMAs to the price data and then subtracting the second EMA from twice the first EMA. The steps to calculate DEMA and the formula for the same are given below.
- Calculate the Exponential Moving Average (EMA) of the price data over a specified period (N). Let’s call this EMA1.
- Calculate the EMA of EMA1 with the same period (N). Let’s call this EMA2.
- Finally, calculate the DEMA using the formula given below.
DEMA = 2 * EMA1 – EMA2
The period for calculation of DEMA depends on the traders and the specific time period of their analysis like 20 days, 50 days, or 200 days or as per their individual preferences.
How is DEMA interpreted in trading?
DEMA is popularly said to be the smoothing indicator that aims to reduce lag and provide a more responsive view of price trends. The interpretation of DEMA for successful trading can be interpreted as under.
Trend Identification
When the stock price rises above the DEMA and continues to increase, it indicates an uptrend. On the other hand, when the stock price falls below the DEMA and the DEMA keeps declining, it signifies a downtrend.
Strength of the trend
The steepness of the DEMA slope can indicate the strength of the current trend. A steep slope suggests a robust trend, while a flatter slope might suggest a weaker or consolidating market.
Crossovers with Price
Traders closely observe crossovers between the DEMA line and the actual price chart. A DEMA crossover above the price chart may implies a potential bullish trend reversal, presenting a buying opportunity. On the other hand, a DEMA crossover below the price chart could signal a bearish trend reversal, indicating a potential selling opportunity.
Divergences
Traders pay attention to divergences between the DEMA and the price chart. A bullish divergence occurs when the price makes lower lows while the DEMA forms higher lows, suggesting a potential trend reversal to the upside. Conversely, a bearish divergence occurs when the price forms higher highs while the DEMA makes lower highs, indicating a potential trend reversal to the downside.
Multiple DEMA Lines
Some traders use multiple DEMAs with different lookback periods on a single chart. These multiple lines can generate suitable trading signals when they intersect aiding traders in making their trading decisions. For instance, a trader might consider buying if a shorter-term 50-period DEMA crosses above a longer-term 100-period DEMA or selling when the 50-period DEMA crosses back below the 100-period DEMA.
What are the advantages and disadvantages of using DEMA?
Some of the popular advantages and shortcomings of using DEMA are tabled below.
| Advantages of using DEMA | Disadvantages of using DEMA |
| DEMA provides a smoother and more responsive moving average compared to traditional simple or exponential moving averages. It reduces lag and provides timely signals. | DEMA involves more complex calculations compared to simple or exponential moving averages, which can be challenging for some traders to understand and implement. |
| DEMA filters out noise and short-term fluctuations in price movements, making it more reliable for identifying trends and significant price changes. | While DEMA is designed to reduce lag, it can still generate false signals during choppy or sideways market conditions, leading to potentially erroneous trade decisions. |
| DEMA’s responsiveness makes it well-suited for volatile markets where prices change rapidly, as it adapts to market conditions more effectively. | Like other moving averages, DEMA relies on past price data, which means it may not anticipate sudden market shifts or news events that impact prices. |
| For short-term traders, DEMA’s ability to capture price changes quickly and filter noise can be advantageous for making timely trading decisions. | |
| DEMA can be quite versatile as it can be applied to different timeframes (from intraday to long-term charts) as well as to different asset classes providing traders with the flexibility to suit their trading styles. |
Conclusion
In order to understand DEMA in a better manner, it is primarily important for traders to understand the concepts of SMA and EMA. This will not only help in understanding the need for DEMA but will also be more suitable for short-term traders and investors. Long-term investors may however still prefer to use the traditional moving averages for analysis of the stocks and other securities.
FAQs
SMA stands for Simple Moving Average, and it is a basic statistical calculation used to determine the average price of a security or asset over a specified period, providing equal weight to all data points within that timeframe. EMA stands for Exponential Moving Average, and it is a type of moving average calculation that gives more weight to recent data points, making it more responsive to recent price changes compared to the Simple Moving Average (SMA).
The basic requirement in calculating DEMA is understanding EMA and its calculation.
TEMA is known as the Triple Exponential Moving Average and it is the advanced technical indicator that applies three exponential moving averages to the price data, further aiming to reduce the lag and provide smoother signals for trend analysis and potential reversals.
DEMA can be a suitable technical indicator for day trading as it has the ability to provide smoother and faster responses to price changes and thereby potentially offering timely signals for short-term trading decisions.
