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How does the triple exponential moving average trading strategy work?

How does the triple exponential moving average trading strategy work?
Asked by
Walter Peters time-icon4 weeks ago
1 Answer Answer Question

Tom Blackstone
Answered time-icon4 weeks ago

The triple exponential moving average (TEMA) is an indicator derived from calculating multiple EMAs of the original EMA derived from an instrument’s price action. The triple EMA was created by Patrick Mulloy, along with the double EMA, and introduced to the world in 1994. The goal of the TEMA was to eliminate the time lag associated with traditional moving averages in order to create an exponential moving average that closely tracked price changes.

How to calculate the triple EMA

  1. The first step is to choose a lookback period, such as 10 or 20 periods, which will be used to calculate the first EMA. The number of periods chosen will determine how closely the TEMA tracks prices.
  2. Then, calculate the EMA for your chosen lookback period; this becomes EMA1.
  3. Next, find the EMA of EMA1using the same number of periods used in the first step; this results in EMA2.
  4. Calculate the EMA of EMA2using the same parameters as before to find EMA3.
  5. Finally, insert the three EMA values into the formula below to find the TEMA.

Triple Exponential Moving Average (TEMA)= (3 ∗EMA1)−(3∗EMA2)+ EMA3

Chart 1: TEMA indicator on GDP/USD 1-hr chart

 

Standard buy and sell signals generated by the TEMA

The TEMA generates a buy signal whenever the price of an asset crosses above the indicator, just like any other moving average. The price is typically said to be in an uptrend whenever it is holding above the indicator for a sustained period of time.

The opposite is true for sell signals, which are typically generated whenever price crosses below the TEMA indicator, indicating that a bearish move may be about to commence. The price is regarded as being in a downtrend whenever it trades below the indicator for a long period of time.

Other trading strategies based on the TEMA

 

Combining the TEMA with the volume indicator

One of the most popular trading strategies based on the triple EMA is combining the indicator with another indicator that tracks the volumes traded to eliminate false buy and sell signals.

Combining the TEMA indicator with a volume indicator is prudent because it helps you ignore buy and sell signals that are not accompanied by higher trading volumes. Such setups are likely to fail because there is no increased buying or selling pressure behind the signals.

Chart 2: GBP/USD 1-hr chart with TEMA and Volume indicators

As you can see from the above chart, some of the most profitable bullish trade signals happened at a time when the volume was rising. One exception is the first one, which occurred as the trend was reversing.

You can also notice that only the first bearish trade signal was accompanied by significant selling pressure as bears fought for control before losing out to the bulls who took over and triggered the next two bullish signals, which were accompanied by higher trading volumes.

 

Combining the TEMA with the VWMA

You can also pair the TEMA indicator with the volume-weighted moving average (VWMA), which is a moving average that gives more weight to price movements that occurred in periods with higher trading volumes.

The basic principle behind this combination is that the VWMA tracks the trading volumes over each period and incorporates that in its readings to create a very reliable moving average indicator.

Chart 3: GBP/USD 1-hr chart with TEMA and VWMA trade entries

The above chart shows that you would have missed some trade entries by relying on the bullish signals generated when the TEMA crosses above the VWMA, despite the latter having a lookback period of 15, which is half of TEMA’s 30 periods.

The crossover signals would also have gotten you into most trades much later when compared to the signals generated by the TEMA when paired with the volume indicator.

 

The bottom line

The two TEMA trading strategies outlined above work quite well depending on your goals as a trader and your risk appetite.

Some traders may prefer to get into trades a bit later after the signal is generated. This can help ensure that it is not a false signal. Such traders may be best served using the TEMA and VWMA combination.

Day traders who want to enter and exit their positions quickly may be best served by the TEMA and volume indicator pairing as they would get into and exit their trade positions much earlier.

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