The Double Exponential Moving Average (DEMA) technical indicator was developed by Patrick Mulloy and published in February 1994 in the journal “Technical Analysis of Stocks & Commodities”. 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.
What is the Double Exponential Moving Average (DEMA)?
The Double Exponential Moving Average is designed to smooth out price series and is superimposed directly on a financial instrument’s price chart. Also, it can be used to smooth the values of other indicators. The advantage of this indicator is that it helps eliminate false signals during a whipsaw price movement and helps to maintain a strong trend.
DEMA can be used instead of traditional moving averages, or its formula can be used to smooth out price data for other indicators that are based on moving averages. DEMA can quickly help determine price reversals compared to the regular EMA, depending on user settings.
Calculation of DEMA
The indicator is based on the exponential moving average (EMA). Consider the error of price deviation from the EMA value:
err (i) = Price (i) – EMA (Price, N, i)
Where:
err (i) – current EMA error;
Price (i) – current price;
EMA (Price, N, i) – the current EMA value from the Price series with a period of N.
Sum the value of the exponential average error to the value of the exponential moving average price, and you get DEMA:
DEMA (i) = EMA (Price, N, i) + EMA (err, N, i) = EMA (Price, N, i) + EMA (Price – EMA (Price, N, i), N, i) =
= 2 * EMA (Price, N, i) – EMA (Price – EMA (Price, N, i), N, i) = 2 * EMA (Price, N, i) – EMA2 (Price, N, i)
Where:
EMA (err, N, i) – current value of the exponential average of the error err;
EMA2 (Price, N, i) – current value of double sequential price smoothing.
Such a popular trading strategy as moving average cross using DEMA will get a new meaning. Let’s compare the signals received from the intersection of 20 EMA with the signals from the intersection of 20 DEMA.
How to use Double Exponential Moving Average (DEMA)?
You can clearly observe that the primary use of the DEMA trading indicator is the same like any other moving average indicator. It’s all about the price crossover. If the price crosses the DEMA line to the upside, we may consider it a bullish trend and if it crosses to the downside, we may consider it a bearish trend.
Bullish Cross in DEMA
The bullish cross occurs when the candle closes above the Double Exponential Moving Average. If the price breaks the DEMA in the upside direction, it can be a signal to close the short positions and to search for long opportunities.
As you can see in the chart above, the price kept moving on the upside after it broke above the DEMA line. Of course, this will not always be the case which is why it is a good idea to practice on a demo trading account to begin with and to combine numerous forex analysis methods.
Bearish Cross in DEMA
The bearish cross occurs when the candle closes below the Double Exponential Moving Average. If the price breaks the DEMA in the downside direction, it can be a signal to close the long positions and to search for short opportunities.
The above chart shows that the price closes under the Double Exponential Moving Average. This gave a decent short trade opportunity.
Double Exponential Moving Average (DEMA) trading strategy
In order to filter signals, we can use the RSI indicator along with the DEMA in our trading strategy.
Double Exponential Moving Average (DEMA) buy strategy
- The price should close above the Double Exponential Moving Average (20).
- The RSI value should be near 30.
- Place the stop-loss near swing low.
- We could exit the trade when the price falls below the DEMA line.
Double Exponential Moving Average (DEMA) sell strategy
- The price should close below the Double Exponential Moving Average (20).
- The RSI value should be near 70.
- Place the sop-loss near swing high.
- We could exit the trade when the price rises above the DEMA line.
Double Exponential Moving Average (DEMA) conclusion
The benefits of incorporating Double Exponential Moving Average in your strategy are numerous. It can make it easier to identify trends and the use of the indicator is no different from using any simple or exponential moving average.
On the other hand, the disadvantages of DEMA are that the clear and strong signals that it gives about the price action may not always be simple and easy to identify.
The main purpose of using the DEMA indicator is to filter out volatility. When a trader wants to focus on an established trend, it can be an invaluable tool. But in cases where volatility is a serious problem, the DEMA may not be the best choice.
The Double Exponential Moving Average indicator can be used on your trading platform charts to help filter potential trading signals as part of an overall trading strategy.
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