Displaced Moving Average (DMA) – Rules, Settings, Strategy, Returns
As traders, we rely on different tools to analyze price movements and gain meaningful insights into the nature and direction of the market — one tool that can help show the direction of price movements is the Displaced Moving Average (DMA). What do you know about this DMA indicator?
The Displaced Moving Average (DMA) is any moving average that has been shifted forward or backward in time by a certain number of periods in an attempt to get a better assessment of the price movements. Displacing the moving average forward or backward may help the indicator better align with the swing highs and lows of the price action, providing a better fit and showing the trend direction more clearly.
In this post, we will take a look at most of the questions you may have about the displaced moving average indicator: what it is, how it works, and how you can use it to improve your trading strategies. Keep reading!
Key Takeaways
- A Displaced Moving Average (DMA) shifts a moving average forward or backward in time by a certain number of periods to better assess price movements.
- Forward or positive displacement shifts the moving average to the right, while backward or negative displacement shifts it to the left.
- The displacement aims to align the moving average with price swings, improving its fit and clarifying trend direction.DMA can help spot dynamic support or resistance levels and accurately identify trends.
- The highly customizable indicator allows traders to adjust displacement based on market conditions or personal preferences.
- It can also assess market reversals and generate potential trading signals.
- We provide you with a backtested Displaced Moving Average (DMA) trading strategy – complete with trading rules and settings.
- Please click here for a technical trading indicators list.
What is a Displaced Moving Average (DMA) in trading?
In trading, a Displaced Moving Average (DMA) is any moving average that has been shifted forward or backward in time by a certain number of periods in an attempt to get a better assessment of the price movements. Displacing the moving average forward or backward may help the indicator better align with the swing highs and lows of the price action, providing a better fit and showing the trend direction more clearly.
A DMA may shift the indicator line to the right, which is referred to as a forward or positive displacement, or to the left, which is known as a backward or negative displacement. The idea is to better align the MA line with the current price action so it can fit more closely with the swings of the price action. This may make it a more accurate tool for spotting trend directions and dynamic support or resistance levels.
Traders can adjust the DMA displacement based on their preferences or the requirements of the market they are trading. Thus, the indicator is highly customizable.
Apart from using it to identify trends and potential support or resistance levels, it can also be used to assess market reversals or create potential trading signals.
Displaced Moving Average trading strategy – rules, settings, returns, and performance
Let’s backtest a Displaced Moving Average (DMA) trading strategy complete with trading rules.
We make the following trading rules:
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Below is the equity curve for S&P 500 (SPY) from its inception until today:
Trading statistics, returns, and performance (including commissions and slippage) for S&P 500 (SPY):
- Number of trades: 930
- Average gain per trade: 0.35%
- Annual returns (CAGR): 9.5%
- Win rate: 72%
- Time spent in the market: 41%
- Risk-adjusted return: 23%
- Max drawdown: 27%
This is the code we used for the backtest (Amibroker):
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How does a Displaced Moving Average (DMA) work?
The Displaced Moving Average (DMA) works like any regular moving average. It can be a simple moving average (SMA) or an exponential moving average (EMA) that is shifted backward or forward. This displacement option is part of the settings of the traditional SMA and EMA indicators on most charting software.
When attaching an MA to your chart, you will see, in the settings box, an option for how much displacement you’d like the indicator to have. For example, in TradingView, it is called “Offset” as in the chart above. In the MT4, it is called “shift”, as in the chart below.
There can also be specific DMA indicators; some with multiple indicator lines that you can shift to different degrees as you want. You set the number of periods to displace the MA, which can be a positive value or a negative value. A positive value will shift the MA line forward (to the right), while a negative value will shift the MA backward or to the left side of the chart.
The displacement is done to make the MA line align better with the price swings, eliminating the distortions caused by lag. Aside from that, the DMA works the same as traditional MAs.
When the current price action is above the MA line (or the level of the MA in the case of left-displaced MA), it may suggest an uptrend, and when it is below the MA line or the level of the MA line, it may suggest a downtrend. The slope of the MA line also confirms the trend direction.
Why use a Displaced Moving Average (DMA) in trading strategies?
You use a Displaced Moving Average (DMA) in trading strategies to better align the indicator line with the swing highs and lows of the price action, providing a better fit and showing the trend direction more clearly. This eliminates the distortions caused by the lagging tendency of the moving average indicator.
As a result, the DMA may work better for your trading strategies than the traditional MAs. It may not only show the direction of the trend more clearly but also provide a better dynamic support or resistance level, depending on the direction of the trend.
How is a Displaced Moving Average (DMA) different from a Simple Moving Average (SMA)?
The Displaced Moving Average (DMA) is different from a Simple Moving Average (SMA) in that the DMA line is shifted to the right or left by a chosen number of periods whereas the SMA plots its line with zero shift.
The DMA can be of any moving average type — SMA, EMA, or any other — but its line is plotted a certain number of periods away from the current price bar. If shifted backward (negative value in the shift setting), the MA line will end the specified number of periods to the left of the current price bar, and if shifted forward (positive value in the shift setting), the MA line will end the specified number of periods to the right of the current bar.
What are the benefits of using a Displaced Moving Average (DMA)?
The benefits of using a Displaced Moving Average (DMA) include:
- It could fit the price action better, eliminating the distortions caused by the MA lagging tendency.
- It may identify the trend direction more clearly.
- It can serve as a dynamic support or resistance level depending on the direction of the trend.
- It may provide a better assessment of potential market reversals when the price crosses the MA line or the level of the MA.
How do you calculate a Displaced Moving Average (DMA)?
The Displaced Moving Average (DMA) is calculated just the same way as any moving average type used for it, which can be an SMA or EMA. If the DMA is based on an SMA, the calculation is that of an SMA, which is given as follows:
n-period SMA = (P1 + P2 + ….Pn)/n
Where:
P = the close price of each period
n = the number of periods
The DMA is then obtained by shifting this SMA plot to the left or right by a given number of periods. To displace the MA to the left, the “Shift” period setting is set to a negative value, say -5 for 5 periods to the left.
Likewise, to displace the MA to the right, the “Shift” period setting is set to a positive value, say +7 for 7 periods to the right.
What parameters are used for a Displaced Moving Average (DMA)?
The parameters used for a Displaced Moving Average (DMA) include:
- The MA type: This refers to the type of moving average used in the DMA. It could be a simple moving average, an exponential moving average (EMA), or even a linear-weighted moving average (LWMA).
- The MA period length: This refers to the length of the period to use in calculating the MA, say 20, 14, or whatever.
- The price source/type: This is the type of price data to use in the calculation. The close price is the most commonly used but it can also be the open, high, low, median, or typical price.
- The Shift/Offset: This is the number of periods and direction to shift the MA plot — say, -5 or +5. It is what makes the MA a DMA.
How does a Displaced Moving Average (DMA) help in trend analysis?
The Displaced Moving Average (DMA) helps in trend analysis by showing how the price swings have been moving relative to the DMA line. If the price is trading above the DMA line, the trend is likely to the upside. This is further confirmed if the DMA is sloping upward.
On the other hand, if the price is trading below the DMA line, the trend is likely to be the downside. This is further confirmed by the DMA sloping downward.
What is the best period setting for a Displaced Moving Average (DMA)?
The best period setting for a Displaced Moving Average (DMA) will depend on your trading strategy and the peculiarities of the market you are trading. If your trading strategy requires you to displace your MA 5 periods to the left or right, then, that should be the best setting for your strategy.
To find out, you have to backtest the strategy on the market you trade to be sure whatever period you’re choosing offers an edge in that market.
How can you adjust the displacement in a Displaced Moving Average (DMA)?
To adjust the displacement in a Displaced Moving Average (DMA), you have to periodically evaluate your trading results to know how well your strategy is performing. This will tell you when you need to adjust the parameters of your strategy, including the displacement of the DMA.
When there is a need to adjust the displacement, you go to the settings of the DMA and change the Shift/Offset setting to the value you prefer. You may have to backtest the new setting to be sure it offers an edge.
What markets are suitable for using a Displaced Moving Average (DMA)?
Every market is suitable for using a Displaced Moving Average (DMA) since the indicator is based only on the price data, which is often available for every market. However, the DMA, as with all moving average indicators, works best in trending markets.
When the market is trending, the DMA slopes in the direction of the trend and may even act as a dynamic support or resistance level where pullbacks reverse for the trend to continue. In sideways markets, on the other hand, the price crosses the DMA frequently, showing to sustained direction.
How does a Displaced Moving Average (DMA) signal buy and sell opportunities?
A Displaced Moving Average (DMA) signals buy and sell opportunities when the price crosses its indicator line in the direction of the trend. A buy signal is generated when the trend is bullish and a sell signal is given in a bearish trend.
For instance, let’s say the trend is bullish, and the price pulls back below the DMA line. When the price crosses back above the DMA, it suggests that the uptrend is about to continue. So, it is a buy signal.
How does a Displaced Moving Average (DMA) reduce lag in trading signals?
The Displaced Moving Average (DMA) reduces lag in trading signals by displacing the indicator line forward (to the right).
So, the indicator line is already plotted before the price gets there. This way, the lagging tendency of the moving average is reduced. However, the trend a forward-shifted DMA shows is that of the period in the past, rather than the future.
Also, the DMA aligns more precisely with the swing highs and lows of the price action, providing a better-fit line for the price swings. This helps to show the trend direction more clearly.
Can a Displaced Moving Average (DMA) improve trading performance?
Yes, the Displaced Moving Average (DMA) can improve trading performance if used with the right trading strategies. The indicator can help you spot the trend faster. It also aligns better with the price swings, offering a dynamic support or resistance level where a pullback can reverse for a trend-continuation trade setup.
However, you will need to combine the DMA with other indicators or price action analysis to formulate a reliable strategy that can improve your trading performance.
What are the limitations of using a Displaced Moving Average (DMA)?
The limitations of using a Displaced Moving Average (DMA) include the following:
- It is based on past price data and can only tell the trend based on what the price did in the past.
- Even when it is shifted forward to reduce the lagging effect of the moving average, the trend it shows is that of the period in the past, rather than the future.
- It does not work in a choppy market condition.
How do you combine a Displaced Moving Average (DMA) with other indicators?
To combine a Displaced Moving Average (DMA) with other indicators, you have to understand how it works so you can use it with other indicators that complement it. Being a trend-following indicator, it makes sense to combine it with a momentum oscillator or a volume indicator.
A volume indicator can show when the market is accumulating or distributing so you can position accordingly. A momentum oscillator will be very useful for swing traders to identify swing trades in the direction of the trend.
What timeframes work best with a Displaced Moving Average (DMA)?
The timeframes that work best with a Displaced Moving Average (DMA) will depend on your trading style and the result of your backtesting. While you can effectively trade on the hourly, 30-minute, or 15-minute timeframe, as a day trader, it’s your backtesting result that will tell you which of them works best for your strategy.
If you are a swing trader, you may have to backtest your strategy on the daily, 8-hourly, and 4-hourly timeframes to see the one that works best.
How can you use a Displaced Moving Average (DMA) for exit strategies?
To use a Displaced Moving Average (DMA) for exit strategies, you have to shift the MA forward and use the price crossover of the indicator line as the exit point.
This works if you use the right indicator period and shift setting that places the indicator line at a good level to exit when the price reaches there. It can be very effective for a trailing stop as it allows you to lock in more profits when riding a trend.
What is the difference between positive and negative displacement in a DMA?
The difference between positive and negative displacement in a DMA is that the former shifts the indicator line forward or to the right, while the latter shifts the indicator line backward or to the left.
A positively displaced DMA tends to reduce the lagging effect of the MA, while a negatively displaced DMA lags even more because the indicator line is further behind the current price action.
Can a Displaced Moving Average (DMA) be used in algorithmic trading?
Yes, a Displaced Moving Average (DMA) can be used in algorithmic trading if it is used to create a reliable trading strategy that can be converted to a trading algo.
The key is to have a tradable logic based on the indicator. For instance, the strategy could be to go long if the indicator is sloping upward and the price crosses above it from below.
How do you interpret crossovers with a Displaced Moving Average (DMA)?
Interpreting crossovers with a Displaced Moving Average (DMA) is simple. When the price crosses above the DMA line, the trend is likely bullish, and when the price crosses below the DMA line, the trend is likely bearish.
You can also combine two or more DMAs of the same “shift” setting such that when the shorter-period MA crosses above the longer-period MA, it signals an uptrend, and the reverse signals a downtrend.
What is the history of the Displaced Moving Average (DMA) in technical analysis?
The history of the Displaced Moving Average (DMA) in technical analysis is as old as that of the simple and exponential moving averages. The DMA is based on those moving averages — it is simply displaced to the right or left of the current price action.
The use of moving averages in technical analysis is as old as the origin of technical analysis.
How does a Displaced Moving Average (DMA) compare to an Exponential Moving
Average (EMA)?
Compared to an Exponential Moving Average (EMA), the Displaced Moving Average (DMA) is simply any moving average that has been shifted forward or backward whereas the EMA is a type of moving average where more weights are given to more recent data.
So, an EMA can be a DMA if the indicator line is shifted to either side of the chart.
What mistakes should you avoid when using a Displaced Moving Average (DMA)?
The mistakes you should avoid when using a Displaced Moving Average (DMA) include:
- Using the DMA without creating a strategy that tells you when to enter and exit the market
- Using the indicator in a choppy market condition
- Using the indicator as a standalone strategy without backtesting it
How can a Displaced Moving Average (DMA) help identify trading reversals?
A Displaced Moving Average (DMA) can help identify trading reversals by showing when the price crosses the indicator line to head in the opposite direction. If the trend has been bullish and the price crosses below the DMA, it could signal a downward reversal if the price continues to move below the DMA.
Likewise, if the trend has been bearish and the price crosses above the DMA, it could signal an upward reversal if the price continues to move above the DMA.