For traders using technical analysis, moving averages are among the top tools that are used to smooth out price action and predict price trends. You may be familiar with indicators like the simple moving average (SMA) and the exponential moving average (EMA). However, did you know that there’s a different type of price action smoothening indicator that belongs to the same family of moving averages? This is the displaced moving average (DMA).
In this article, we’ll explore what the DMA in the stock market is, understand why it’s needed and discuss its limitations.
What Is DMA in the Stock Market?
The DMA or displaced moving average is a moving average that has been displaced on a stock market chart by moving it forward or back in time. This helps you forecast a trend better or understand the current price movements more effectively.
The DMA in stock market charts is computed in the same manner as a simple moving average. This SMA is then adjusted forward or back on the chart by a specified number of periods to create a lagging or futuristic moving average line.
Why is the Displaced Moving Average Used in the Stock Market?
When you use a standard moving average, it calculates the average price of a stock (or any financial instrument) over a specified period and plots this average along with the price on a chart. This moving average helps you identify the general trend of the price – whether it’s going up, going down or staying relatively stable.
However, standard moving averages have a limitation: they are centred only around the period they cover. This means if you’re using a 10-day moving average, the average price it shows today is actually centred around the prices from 5 days ago (i.e. half of 10 days). In fast-moving volatile markets, this can make the moving average lag behind the current price trend.
Displacing the moving average, that is, shifting it forward or backward, is a way to adjust for this lag. It helps you either align it more accurately with the current market trend or project where the trend might go in the future. Thus, a displaced moving average can provide a different perspective compared to the standard moving average and potentially offer more timely insights for trading decisions.
Here’s how it works:
Forward Displacement
When you shift the moving average forward (to the right on a chart), you’re essentially trying to anticipate where the trend is going. Doing this means that you expect the current trend to continue in the same direction. This helps you make decisions based on where you expect prices to be in the future, rather than where they have been in the past.
Backward Displacement
Conversely, shifting the moving average back (to the left on a chart) aligns it more closely with the current market situation. This is usually done because the average usually lags behind the current price. So, you shift it back to better match the prevailing market movements. This is crucial for identifying the current trend.
What Does the Displaced Moving Average Tell You?
A displaced moving average helps you understand two key aspects — market trends and support and resistance levels. Let’s explore these insights from the DMA in the stock market.
Understanding Market Trends Using the Displaced Moving Average
When the price of an asset is consistently above the DMA, it indicates an uptrend. Conversely, if the price is below the displaced moving average, it suggests a downtrend. By displacing the MA forward or back, you can adjust for the lag that’s typical in a standard moving average. This gives a clearer picture of the current trend. For example, displacing the MA forward might help confirm that a current uptrend is likely to continue.
Understanding Support and Resistance Levels Using the Displaced Moving Average
The displaced moving average can act as a dynamic level of support or resistance. In an uptrend, the DMA serves as a support line, where the price finds a floor and bounces back up. In a downtrend, it acts as a resistance line, where the price finds a ceiling and drops back down. By displacing the moving average, you can align it more closely with recent market behaviour.
Also Read More About How to Use Moving Averages for Stock Trading?
Displaced Moving Average (DMA) vs. Exponential Moving Average (EMA)
Although the DMA and the EMA are both used in technical analysis, they are different in many ways. Check out how these two indicators compare with one another.
| Particulars | Exponential Moving Average | Displayed Moving Average |
| Meaning | A type of moving average that gives more weight to recent prices | A standard moving average shifted forward or back in time |
| Purpose | To react more quickly to recent price changes (when compared to a simple moving average) | To align the moving average more closely with current trends or to anticipate future trends |
| Calculation | Calculated by applying a weighting factor to the most recent price data | Based on a standard moving average and then displaced by a set number of periods |
| Lag Factor | Reduces lag by giving more weight to recent data, making it more responsive | Attempts to reduce lag by time displacement but doesn’t eliminate it |
| Adjustment | Adjusted by changing the weighting factor to make it more or less responsive | Adjusted by shifting the period forward or back |
| Best Used In | Markets where quick reaction to price changes is crucial | Trending markets where the goal is to align with current trends or anticipate future movements |
| Price Sensitivity | Highly sensitive to recent price changes | Sensitivity depends on the type of moving average chosen before displacement |
| Complexity | More complex calculations due to the weighting of recent prices | Relatively simple to calculate but the displacement period needs to be decided |
| Uses | Often used by traders who need a faster response to price changes | Used to better align with current trends or project future movements in a more visual way |
| Risks | Risk of overreacting to minor price changes and market noise | Potential risk of misinterpreting trend direction due to displacement |
Limitations of DMA in the Stock Market
Despite its various uses, the displaced moving average also comes with certain limitations. It’s important to be aware of these limitations, so you can make informed trading decisions. The downsides of the DMA in stock market charts include the following:
Lag Issues
Even though the primary purpose of the displaced moving average is to adjust for the lag inherent in standard moving averages, it doesn’t completely eliminate the lag. In fast-moving markets, this can still result in delayed signals and lead to missed opportunities or late entries into trends.
Subjectivity in Displacement
The choice of how many periods to displace the moving average is subjective and varies greatly among traders. This lack of standardisation can lead to inconsistent interpretations and results, making it challenging to establish a one-size-fits-all approach.
False Signals in Sideways Markets
In range-bound or sideways markets, the displaced moving average, like other trend-following tools, can generate false signals. This occurs because moving averages are primarily designed for trending markets and may not accurately reflect market dynamics in periods of low volatility or consolidation.
Risk of Over-Reliance
There is also the risk that you may become over-dependent on displaced moving averages for decision-making and ignore other crucial market factors — such as fundamental analysis, market news and economic indicators. This over-reliance can lead to a narrow view of the market and put you at risk of overlooking key risks or opportunities.
Ineffective in Uncertain Markets
During choppy market conditions where the prices fluctuate wildly, the displaced moving average might provide little to no useful information. It may frequently cross the price line, leading to confusion and potentially misinformed trading decisions.
Not a Standalone Tool
The displaced moving average should not be used in isolation. It’s most effective when combined with other technical analysis tools and indicators to confirm trends, reversals or breakout points. Relying solely on the displaced moving average without confirmation from other sources can lead to misguided trades.
Points To Remember While Relying on the DMA in the Stock Market
Before you rely on the DMA in the stock market, it’s crucial to remember the following points.
Context Matters
DMAs are most effective in trending markets. Be cautious in sideways or highly volatile markets because DMAs might give misleading signals.
Displacement is Subjective
Choosing the displacement period is subjective and requires experimentation. There’s no one-size-fits-all setting, so adjust the DMA based on your trading strategy and analysis.
Use with Other Indicators
Displaced moving averages should not be used in isolation. Combine them with other technical indicators to validate signals and form a more comprehensive market view.
Beware of the Lag
Despite the displacement, DMAs can still lag behind real-time market movements. Be aware of this inherent delay and its potential impact on your trading decisions.
Backtesting is Key
Before applying a displaced moving average in live trading, backtest it on historical data to gauge its effectiveness and make any adjustments that may be necessary.
Conclusion
A displaced moving average is a statistical tool that helps you analyse market movements more comprehensively and determine your entry and/or exit points after accounting for lags or future trends. Modern advanced charting tools can automatically adjust the standard moving average for the period required. All you need to do is make informed decisions about the duration and the direction of displacement required, if any.
FAQs
While a regular moving average plots the average price over a specific period based on current and past data, a displaced moving average shifts this average to the left (back) or right (forward) on a chart. This shift is intended to reduce the lag inherent in standard moving averages or to project future trends.
You can use a displaced moving average to minimise the lag effect found in traditional moving averages. This allows you to better align your strategy with the current market trends. It can also be used to speculate on future price directions.
First, you calculate the standard moving average (like a simple or exponential moving average). Then, displace this average by a certain number of periods forward or back. The displacement number can be chosen based on your preference and strategy.
Yes, displaced moving averages can be applied to any time frame, whether it’s short-term (like minutes or hours), medium-term (like days) or long-term (like weeks or months). The choice of time frame depends on your trading strategy and objectives.
Whether a displaced moving average is better than a standard moving average depends on your trading goals and the general market conditions. DMAs can offer a different perspective, especially in trending markets, but they are not inherently superior and should be used as part of a comprehensive trading strategy.
