What is the Weighted Moving Average (WMA)?
The weighted moving average (WMA) is a technical indicator that traders use to generate trade direction and make a buy or sell decision. It assigns greater weighting to recent data points and less weighting on past data points. The weighted moving average is calculated by multiplying each observation in the data set by a predetermined weighting factor.
Traders use the weighted average tool to generate trade signals. For example, when the price action moves towards or above the weighted moving average, the signal can be an indication to exit a trade. However, if the price action dips near or just below the weighted moving average, it can be an indication of a favorable time to enter a trade.
Using the weighted moving average to determine trend direction is more accurate than the simple moving average, which assigns identical weights to all numbers in the data set.
How The Weighted Moving Average Works
Now that you know how to calculate the weighted moving average of a given set of values, let’s look at how you can use this indicator for your trades:
- To help determine trend direction – When the price is above its weighted MA line, it’s usually a signal that on average, the asset is trading higher than it has over the period being analyzed. This in turn confirms an uptrend. Alternatively, when the price is below the WMA line, then it confirms a downtrend.
- To indicate support and resistance areas – A rising weighted MA can indicate support for price action. While a falling WMA can indicate resistance to price action over a given period. Traders tend to use this as a strategy to place buy orders when the price is near the rising WMA or place sell orders when the price is near the falling weighted MA.
- To validate price strength and market momentum – Price action above its moving average shows that the market is getting stronger relative to where it was in the past since the most recent prices now sit higher than the average. On the flip side, price action below its moving average shows that the market is getting weaker relative to where it was in the past.
- To measure price movement – The weighted moving average is generally more sensitive to price movement making it a better measure as well as identifying trends sooner than the SMA. However, this can be a double-edged sword as the WMA is likely to experience more volatility than its corresponding SMA.
- To provide trade signals – The WMA can be incorporated with other technical indicators like Keltner Channels to spot ideal trade signals. Traders can enter the market near the WMA during an uptrend and there is a price pullback from the top of the Keltner Channel.