Linear Weighted Moving Average

The LWMA (Linear Weighted Moving Average) is a popular and commonly used indicator. It was created in an attempt to improve the MVA indicator, which has significant lag behind market prices and a twofold impact of one and the same price on the indicator’s calculation. During the calculation of the LWMA indicator, some extra value (weight) is applied to the average price. This procedure is used to compute all of the price values of the indicator on the chart. The increased weight allows the most recent prices to play a larger role in the calculation, while the relevance of all previous ones decreases linearly. As a result, the LWMA indicator reacts faster to market price movements, making its lag less substantial than that of the MVA indicator.

What is the Linear Weighted Moving Average?

A linearly weighted moving average (LWMA) is a moving average computation that weights recent price data more highly. The most recent price has the most weight, and each previous price has less weight. The weights fall in a straight path. LWMAs react to price changes faster than simple moving averages (SMAs) and exponential moving averages (EMAs). The linearly weighted moving average is the continuous calculation of an asset’s average price over a specific period. It aids in the reduction of noise, allowing you to easily observe what the price is doing. You can use it to see the overall trend as well as specific price fluctuations. When the price is above the LWMA and the LWMA is rising, an uptrend is expected; when the price is below the LWMA and the LWMA is pointing down, a downtrend is likely.

Setting up the Linear Weighted Moving Average
Setting up the Linear Weighted Moving Average

Linear Weighted Moving Average Strategy

To use the LWMA Strategy, the trader could set the average period to a large number, such as 100 or 200, to utilize the LWMA to illustrate a trend. Lower numbers cause the indicator to track the price more closely, and instead of displaying the trend, it displays individual price swings. When trading, you can use the LWMA to do a variety of things. One of them is to determine the trend’s direction. When utilizing LWMA to determine a trend, it can also function as a support or resistance level during an uptrend or a support or resistance level during a decline. For example, if a bullish candlestick pattern, such as the hammer, appears after a pullback, it could indicate the conclusion of the pullback and the continuation of the uptrend.

Buy Signal

This could be your checklist for a buy trade:

  • When price is trading above the LWMA.

Once this event occurs:

  • You could open a buy position after you confirm your entry with bullish candlestick patterns.
  • You could set your stop loss just below the nearest swing low.
  • You could set your take profit at the nearest resistance zone, or you could exit trade when price falls below the LWMA.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Linear Weighted Moving Average Buy Setup
Linear Weighted Moving Average Buy Setup

Sell Signal

This could be your checklist for a sell trade:

  • When price is trading below the LWMA.

Once this event occurs:

  • You could open a sell position after you confirm your entry with bearish candlestick patterns.
  • You could set your stop loss just above the nearest swing high.
  • You could set your take profit at the nearest support zone, or you could exit trade when price rises above the LWMA.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Linear Weighted Moving Average Sell Setup
Linear Weighted Moving Average Sell Setup

Linear Weighted Moving Average Pros & Cons

Pros

  • The Linear Weighted Moving Average can be a beneficial tool in a trending market which could enable traders ride long trends without exiting trades too quickly.
  • This indicator may provide dynamic support and resistance levels; hence the traders could manage their trades accordingly.

Cons

  • When the price action is choppy or moving mostly laterally, this indicator provides little information. Because the price will bounce around the LWMA during such periods, the LWMA will not produce appropriate crossover or support/resistance indications.
  • The Linear Weighted Moving Average is capable of producing several false signals. A false signal occurs when the price crosses the LWMA but then fails to move in the expected direction, resulting in disastrous trades. It is not unusual to have several false signals before a substantial trend emerges.

Conclusion

The linear-weighted moving average, often known as a weighted moving average, is a basic moving average that gives more weight to recent data. The most recent observation has the highest weight, whereas the ones before it have gradually less weight. It has less lag than the other moving averages intuitively, but it is also the least used, so what it gains in lag reduction it loses in popularity. In addition, while this approach is simple for a novice trader, it can be dangerous without sufficient training and expertise. Some of the signs may be misleading, and we may enter the trade too late or too quickly, resulting in a loss.