The triple exponential moving average (TEMA) is an important indicator for traders and analysts as it is an indicator of trend of stock prices. Used in conjunction with other technical analysis tools and indicators, the TEMA is a useful indicator in extremely volatile markets. It minimizes the effects of extremely large fluctuations in price that helps in filtering out the price volatility. It serves as a modified moving average technique that flattens the shocks in price. The TEMA actually provides signals by applying several calculations to previous EMA values, which makes it a critical tool available to traders and analysts for performing advanced trend analysis on markets.
TEMA serves as an useful indicator for analyzing price trends and smoothen out price fluctuations. It is a variation of the traditional EMA that provides more accurate signals and responses. The established moving averages identify trends but incorporate lags that is a drawback. The TEMA, on the other hand, identifies trends more precisely, minus the lag for common moving averages. The TEMA achieves this by numerous exponential moving averages of the primary exponential moving averages and then deleting the lag. In a way, the TEMA is a marked improvement over several other exponential moving average techniques proposed previously for technical analysis of stock price trends. Read more to find out the history and development of TEMA, formula and calculation of TEMA, why is TEMA essential in trading, and a comparison of TEMA vs. other moving averages.
History and Development of TEMA
The triple exponential moving average was developed by Patrik Muloy and was published in 1994 as an article titled “Smoothing Data With Faster Moving Averages” in the “Technical Analysis of Stocks & Commodities” magazine. Mullay proposed that there was a way around the lag time of existing exponential moving averages. This modified statistical version has lesser lag time that could be used in technical analysis of prices of securities. Generally, the noise level or fluctuations of a time series such as stock prices can be reduced by increasing the moving average length. But this increasing moving average also increases the lag time.
The solution to the above problem was a modified statistical version of the exponential moving average that reduces the fluctuations while simultaneously reducing the lags. In the same article, Muloy also proposed DEMA or the double exponential moving average. The triple exponential moving average becomes a very important tool for traders and analysts because it uses consecutive EMA of EMAs, and its formula adjusts for the lag time. One of the most important indicators of price trend, the TEMA is quite effective in predicting trends that are sustained over longer time durations. In those periods of longer trends, the time durations of volatility can easily be filtered and flattened out. The TEMA is usually used with other oscillators and technical indicators to analyze price fluctuations. A usually recommended combination is the usage of the TEMA and the MACD.
Formula and Calculation of TEMA
Once the time period of analysis is chosen, the starting fEMA needs to be calculated. Afterward, the second EMA, or the double exponential moving average, is computed from the previously obtained EMA. The third and the last step involves calculating another EMA of the DEMA after which the TEMA is obtained. The TEMA can be represented as follows:
TEMA = (3 x EMA1) - (3 x EMA2) + EMA3
Here, EMA1 = initial exponential moving average
EMA2 = exponential moving average of EMA1, and
EMA3 = exponential moving average of EMA2
Since EMA3 is essentially equivalent to EMA(EMA(EMA)), the TEMA needs three periods and two samples to produce values. The EMA2, i.e., EMA(EMA) is subtracted thrice from the previously triple EMA in order to remove the lag in the analysis model.
You can follow the below-mentioned steps to calculate the TEMA -
Decide a particular period of analysis. This is the period that will be considered in the first EMA for analysis. If the period is short, i.e., 5 years, the prices will be tracked more closely by the EMA and more short-term trends will emerge from the analysis. If the period of analysis is long, i.e., 80 years, the price tracking will not be done very closely but instead long-term price trends will be highlighted.
After deciding the period, calculate the first EMA which is referred to as the EMA1.
By using the same period of analysis, find out the EMA(EMA1), i.e., the exponential moving average of EMA1. If you use 10 periods of analysis while calculating EMA1, then use the same 10 periods for calculating EMA of EMA1. This becomes your EMA2.
Then determine the EMA of EMA2 using the very same 10 periods of analysis as done previously. This becomes your EMA3.
Substitute the values for all the EMAs into the formula to finally determine the triple exponential moving average.
Why Is TEMA Essential in Trading?
The TEMA supports traders and analysts by providing valuable information about stock price movements and fluctuations. In general, the TEMA responds to changes in prices quicker than parameters such as conventional EMA or MA because the lag time has been subtracted from TEMA calculation. Especially, the TEMA gives information about the below-mentioned points -
Direction of trend
You can find out the direction of the market simply by viewing the slope of the TEMA line. A TEMA line with an upward pointing slope with the prices above the line indicates that the market is experiencing an upward trend. This points to the fact that the prices, in general, are increasing. On the contrary, a TEMA line with a downward slope with the prices below the line suggests that the market is experiencing a downtrend, i.e., prices are declining overall.
Crossovers
TEMA can also be used by traders as an indication of crossovers with a buy and sell recommendation. Whenever the price line crosses above the TEMA, it can suggest a strong bullish pattern, i.e., an upward trend in the near future. On the other hand, once the price line crosses below the TEMA, there is a strong indication of a downward trend coming in the near future. Traders can get a sense of when to buy and sell stocks based on these crossover signals.
Resistance and support
TEMA can also help analysts and trends determine the support and resistance levels for stocks. The price line shows dynamic resistance and support levels. Whenever the price touches the moving average, a rebound is expected from that level. If the line signal breaks, then it could be an indication of a reversal of trend.
TEMA vs. Other Moving Averages
Following are the differences between the triple exponential moving average and the double exponential moving average:
| TEMA
| DEMA
|
Computation
| The EMA calculation is applied thrice. Essentially, it is EMA(EMA(EMA)). So, three levels of exponential smoothing are applied.
| The EMA calculation is applied twice and it is EMA(EMA). Here, two levels of exponential smoothing are applied.
|
Lag time decrease
| Usually has lesser lag because the EMA2 is subtracted thrice from 3 x EMA1
| Usually has more lag than the TEMA because the EMA2 is subtracted once 2 x EMA1
|
Price responsiveness
| More responsive to changes in price
| Less responsive to changes in price
|
Generation of price signals
| Earlier than DEMA
| Later than DEMA
|
Smoothness of indicator
| Less smooth than the DEMA.
| More smooth than the DEMA
|
TIme duration of fluctuations
| Helps filter out long-term fluctuations
| Helps filter out short-term fluctuations
|
Applicability
| More suitable for short-term markets with high market volatility
| More suitable for medium-term markets with medium volatility
|
Conclusion
While the triple exponential moving average represents an improvement over the conventional exponential moving averages, you need to be well aware of its limitations. The TEMA shares some of the downsides of moving averages. Usually, moving averages work well when the market prices indicate a consistent pattern either in the upward or in downward direction. But during volatile periods, established moving averages as well TEMA provide not many insights. Additionally, they may give out several false signals due to multiple crossovers generated due to the price volatility. Therefore, if the market does not signal a specific trend, using TEMA may not necessarily work and you may need other indicators.
Another limitation of TEMA is that though it reduces the lag, it does not completely eliminate the lag. So, complete reliance on TEMA may not bring out the most recent price actions. The calculation of TEMA is somewhat convoluted and not every trader will be comfortable in using TEMA for their analysis. The quicker response time of TEMA suggests that it tracks the price very closely and reflects more fluctuations resulting from frequent crossovers compared to other common moving averages. This may be beneficial for traders with a short-term horizon. However, traders or investors who have a long-term investment horizon may not find TEMA to be an effective tool for analyzing price movements. The extreme responsiveness of TEMA may also lead to over-sensitivity which may lead to errors in decision-making during volatile markets because of false signals.
Investing in the share market or even futures and options is not a straightforward approach because you need to combine multiple types of indicators such as TEMA along with other advanced charting tools. You need to consider your risk appetite and investment goals while using indicators for technical analysis. Your tools for analysis will vary depending on whether you are a short-term trader or a long-term investor. Tools are, at best, indicators but if you want to be a seasoned investor, you need to know which tools to apply in what types of markets in order to maximize your wealth!