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Weighted Moving Average (WMA): How to Use It in Trading?

Adam Lienhard
Adam
Lienhard

The Weighted Moving Average, also known as WMA, is a technical indicator used by traders to determine the direction of trade and make buy or sell decisions. It gives more importance to recent data points and less to past data points. To achieve this, each observation in the data set is multiplied by a predetermined weighting factor. Learn more about WMA to use it for profits.

What is WMA?

The Weighted Moving Average (WMA) is different from the Simple Moving Average (SMA), which assigns an equal weight to all numbers. In WMA, the most recent data point is assigned a weight of 1, the second-most recent data point is assigned a weight of 0.9, and so on. This means that the most recent data points are given more importance in calculating the moving average, making the WMA more responsive to recent price changes.

Here’s how you calculate a 5-period WMA:

WMA = (P1 * 5) + (P2 * 4) + (P3 * 3) + (P4 * 2) + (P5 * 1) / (5 + 4+ 3 + 2 + 1)

In this formula, P1 to P5 represent the price data points for the 5 periods.

Why use WMA?

When it comes to trading, the Weighted Moving Average (WMA) can be a useful tool for generating trade signals. If the price action moves towards or above the WMA, it may be a good time to exit a trade. Conversely, if the price action dips near or just below the WMA, it may be an indication of a favorable time to enter a trade.

It’s worth noting that while the WMA can identify trends earlier than a Simple Moving Average (SMA), it may also experience more whipsaws, i.e., sudden and drastic changes in price. Therefore, it’s crucial to use the WMA in conjunction with other indicators and strategies to confirm signals and manage risk.

How to use WMA?

The Weighted Moving Average (WMA) can be used in trading to generate trading signals, much like other technical indicators. Follow the steps to make the most of it:

Step 1. Calculate the WMA

To calculate the WMA for a specific period, you need to take into account the closing prices of the last few days. The WMA assigns greater importance to recent data points as compared to older ones. For instance, if you want to calculate a 10-day WMA, you should consider the closing prices of the last 10 days.

Step 2. Identify potential trade signals

After obtaining the WMA, you can use it to identify potential trade signals. 

For buy signals. When the price of an asset crosses above the Weighted Moving Average (WMA), it can be a signal to buy. The WMA is a trend indicator, and a bullish crossover (price crossing above the WMA) can indicate that the price is moving upwards.

For sell signals. When the price of an asset crosses above the Weighted Moving Average (WMA), it can be a signal to buy. This is because WMA is a trend indicator, and a bullish crossover (price crossing above the WMA) can indicate that the price is moving upwards. Conversely, when the price of the asset crosses below the WMA, it can be a signal to sell. This is because the WMA is still a trend indicator, and a bearish crossover (price crossing below the WMA) can indicate that the price is moving downwards.

Step 3. Confirm the signal with other indicators

While the WMA (Weighted Moving Average) can provide useful signals, you need to confirm these signals with other indicators to avoid false positives. For instance, you could use a trendline indicator to confirm the trend indicated by the WMA. Similarly, you could use a Relative Strength Index (RSI) to confirm the strength of the trend. This will help you to make more informed trading decisions.

Step 4. Set Stop Loss and Take Profit levels

It’s crucial to establish the Stop Loss and Take Profit levels for your trades. For a long position, set the Stop Loss level below the WMA, and for a short position, set it above the WMA. The take profit level should be a comfortable level for you and allow some room for the price to fluctuate.

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