Weighted Moving Average

Technical indicators, many traders may agree, are at the heart of any trading system. Traders use them to estimate future market movements and evaluate past price trends and patterns in order to make informed trades. While there are many other types of indicators available to traders today, one of the most common is the weighted moving average (WMA). This is due to its simple formula and ability to measure market momentum.

What is the Weighted Moving Average?

The weighted moving average (WMA) is a technical indicator used by traders to establish trade direction and decide whether to buy or sell. It gives more weight to recent data points and less weight to previous data points. Each observation in the data collection is multiplied by a predefined weighting factor to generate the weighted moving average. The weighted average tool is used by traders to produce trade signals. The weighted moving average may work better than the simple moving average in determining trend direction since it applies identical weights to all integers in the data set.

WMA compared to SMA
WMA compared to SMA

Weighted Moving Average Strategy

When the price is above its weighted MA line, it usually indicates that the asset is trading higher on average than it has over the period being studied. This confirms an upward tendency. When the price falls below the WMA line, it confirms a downward trend. A rising weighted MA can signal price support. While a dropping WMA can signal price resistance over a specific period. Traders may employ this approach to place buy orders around the rising weighted MA and sell orders near the falling weighted MA. Price activity above its moving average indicates that the market is strengthening relative to where it was previously, as the most recent prices are currently higher than the average. Price activity below its moving average, on the other hand, indicates that the market is weakening in comparison to where it was previously.

Buy Signal

This could be your checklist for a buy trade:

  • When price is trading above the WMA.

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 WMA.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Weighted Moving Average Buy Setup
Weighted Moving Average Buy Setup

Sell Signal

This could be your checklist for a sell trade:

  • When price is trading below the WMA.

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 WMA.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Weighted Moving Average Sell Setup
Weighted Moving Average Sell Setup

Weighted Moving Average Pros & Cons

Pros

  • The Weighted Moving Average can be used by traders to identify the prevailing trend direction of an asset.
  • This indicator can also be used to provide dynamic support and resistance levels.

Cons

  • When the price action is choppy or moving mostly laterally, this indicator may provide little information.
  • The Weighted Moving Average is capable of producing lagging signals which would negatively affect the trader’s risk to reward ratio.

Conclusion

Understanding how to use the weighted moving average in conjunction with other technical indicators is a valuable ability. That being said, one sort of moving average isn’t inherently better than another because they just use different methodologies to calculate average values. As a result, your trading approach will ultimately determine which type of MA is most effective. You may want to consider modifying your settings significantly for each market; for example, a 50-period WMA may offer excellent indications on one stock but not on another. The trick, as with any other tool, is to understand how to use and interpret the WMA to get the greatest results from your trades. Take note, however, that the WMA do not guarantee profits.

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