Double Exponential Moving Average (EMA)

Definition

The Double Exponential Moving Average (EMA) is a technical indicator that uses two moving averages to help confirm uptrends when price moves above average, and confirm downtrends when the price moves below average. A trend change might be occurring when the price moves in a direction away from the average. In addition, moving averages can be used to signify support and/or resistance territories. 

History 

The Double EMA was first introduced by Patrick Mulloy in his article from 1994 titled, “Smoothing Data with Faster Moving Averages.” His article was published in Technical Analysis of Stocks & Commodities magazine.

Calculations

The formula for Double EMA is as follows:

DEMA = 2 × EMAN − EMA of EMAN

Definition:

N= Look-back period

1. To calculate Double EMA, first choose the look-back period you would like to examine (i.e. five, 15, 100 periods).
2. Once you have selected your period, go ahead and calculate the EMA for that period (EMAN). 
3. Then apply a different EMA with the same lookback period to EMAN
4. To finish, multiply the EMANby two and subtract the smoothed EMA amount. Now you’re all set.

Takeaways

The Double EMA has a quicker response when compared with traditional EMAs and can be used in the same ways. Remember that if you are using Double EMAs that it reacts quicker and therefore you should be planning your strategies around this information - alterations may be in order.

If working with a longer timeframe (e.g. 100 periods), keep in mind that the Double EMA will react slower than if you were using a shorter timeframe (e.g. 10 periods).

What to look for

The formula listed above does not rely on using the double exponential smoothing factor, rather it doubles the EMA and consequently cancels out the lag by subtracting smoothed EMA. The calculations, as you might have been able to tell, are a little complicated and therefore need more conclusive data instead of pure EMA calculations alone. Today, it is easier to calculate Double EMAs because of modern technology and charting.

Double EMAs are more advanced than traditional moving averages and react quicker, making them more sought after by day and swing traders. Investors also use Double EMAs, but usually stick to traditional moving averages since long-term investors tend to be less active in their assets.

Limitations

Traditional moving averages are good to use to identify trends in markets, but they don’t give much data when prices are choppy or not smooth. When price crosses the moving average or Double EMA, it is difficult to determine results and decide on when a trade will be profitable.

For this reason, it is great to pair the Double EMA with other technical indicators, or other price and/or fundamental analysis tools. By pairing the Double EMA, investors and traders can better determine market trends while looking at the big picture, and not getting hung up on the limitations or focusing on one sole indicator.

To conclude our limitations section, one thing to note would be the significance of reducing lag. Reducing lag can be beneficial in some instances, such as if there is a reversal in actual price. It can help get a trader out quickly and before any major losses occur. However, reduced lag may also result in something called overtrading; when an indicator provides a trader with too many signals at once. An indicator that has less lag is also more susceptible to reacting to small shifts in price that would normally not have a large effect. So remember that lag can be good at times, but at others it can really get in the way. It is up to the trader to decide whether or not lag is something they want or need from their indicator.

Summary

The Double EMA is an indicator that identifies uptrends and downtrends in the current market. It responds quicker than traditional moving averages and can be used with other indicators to help traders analyze overall market trends. Make sure to look into lag if you will be utilizing Double EMAs so that you can determine if reducing lag will be what is best for you and your trade.