How to read and use the moving average weighted trading indicator
This useful tool is based on the current price in relation to past prices
The moving average weighted or weighted moving average (WMA), is a technical analysis tool which can help you identify or confirm trend direction. This indicator is based on the current price in relation to past prices. In other words, it assigns a higher weight to the newest prices and lower weights to older data points, meaning that the importance of the data moves linearly.
The idea behind such a weighting system is that the most recent prices are more reliable when it comes to anticipating the price movements. For example, the simple moving average, another trading indictor, assumes equal importance to each price – the most recent or the oldest one. So, SMA is calculated by adding up all prices and dividing their sum with the number of periods included in the analysis.
Unlike the SMA, the moving average weighted calculation is performed by assigning a specific weight to each price, and the weight depends on the number of periods considered. You calculate the WMA by multiplying each period price with the associated weight. Just add these values and divide the sum by the sum of the weights. Here is how the general formula for the WMA looks:
WMA = (Sum of weighted averages) / (sum of weights)
How to read the weighted moving average indicator
The weighted moving average indicator is displayed as a line directly on your price chart. If the line is moving below the price action, it points toward a rising trend while a line moving above the price suggests a downward trend.
Note that depending on the trading platform, you can either select the WMA directly or you need to select the moving average indicator tab first and select the weighted moving average afterwards.
The blue line, which is close to the price represents the 20-days moving average weighted indicator. The section with the red arrows shows that the line is above the price and there is a decreasing trend whereas the blue arrows point toward a section where the WMA line is below the price detecting an upward trend.
The indicator is also used by traders to identify certain price levels or to wait for alerts when potential trend reversal can occur. Accordingly, an increasing weighted moving average can be seen as a support to the price action, whereas a decreasing line may act as a resistance level of the price.
One way to identify potential buy and sell signals is to look at price crossover points.
- If the price crosses over the WMA line, then it can show potential buy opportunity.
- If the WMA line crosses over the price, traders may sell or short sell the underlying asset.
Since the WMA can act as a support or resistance, traders can use the indicator in a similar way to look for potential trading opportunities.
- When WMA acts as a resistance, you can make a sell transaction when the price touches the line.
- If the indicator serves as a support level, traders can buy the instrument when the price touches the line.
Let's look at the graph below.
You can see how the WMA line acts as a support or resistance as well as how a price crossover would look like. The points shown with the red lines indicate potential alert where the price crosses over or below the WMA displaying potential changes in trend direction.
At the area shown with the blue arrows, the WMA line serves as a support level since every time the price touches the line it moves back again. The opposite happens in the section shown with the red arrows. The WMA line acts as a resistance level and every time the price reaches the WMA it bounces and continues to move downward.
You can plot two WMA with different time frames. In such case, the trading alerts are identified through crossovers between the shorter period (or faster) and longer period WMA lines.
- A bullish signal is anticipated when the shorter period WMA crosses above the longer period moving average weighted line.
- Possible bearish movement is detected when the shorter period WMA crosses below the longer period WMA.
Potential trading opportunities identified by WMA crossovers are shown in the next graph.
You can see that each time the shorter period WMA crosses below the longer period WMA (yellow arrows), the trend moves downward. And when shorter WMA crosses above the longer WMA (blue arrow), it anticipates upward trend direction.
Another moving average weighted strategy which can be used by traders is to combine shorter and longer periods EMAs and WMAs along with a momentum indicator. In such a setup, traders look for potential entry and exit positions by looking at the areas formed by the moving averages and the way how they crossover along with the alerts provided by the momentum indicator.
More advanced traders may develop moving average weighted trading strategies by combining the WMA indicator with other tools, but these strategies can quite often be a bit complicated, especially for beginners lacking trading experience.
The weighted moving average indicator comes with certain drawbacks. For example, it provides a trend confirmation but with certain lag in the potential entry and exit points. Also, the higher sensitivity to price movements, which is as an advantage, can also be a drawback because traders can end up with more whipsaws compared to the simple moving average.
Finally, the WMA accuracy and reliability decreases during a range-bound market condition which is hindering the crossover signals as well as the support and resistance alerts.
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