WMA (Weighted Moving Average)

Introduction

Stocks, securities, and even cryptocurrencies have all managed to capture the eyes of many investors, serving as a means of maximizing income and even protecting against inflation. 

However, anyone who has even remotely acquainted themselves with the stock industry will know that navigating it isn’t exactly easy. 

Making the most out of your investments requires you to be intimately familiar with the inner workings of the sector, how the market is currently performing, or which direction it’s supposed to be going in.

Fortunately for you, there are various indicators that can make things less frustrating and give you a bit of a heads up. 

These come in the form of technical indicators like simple, exponential, and weighted moving averages. But the one we’ll be discussing today would be the weighted moving average, or WMA, for short.

What is the Weighted Moving Average (WMA)?

So, what is the WMA, or the weighted moving average? Simply put, it’s a technical trading indicator, allowing those engaging with it to make buying and selling decisions or generate trading directions. 

It assigns higher weighting to the latest data points and lower weighting to previous data points. 

The WMA is therefore calculated through the multiplication of every observation within a set of data with predetermined weighting factors.

The Purpose of WMA

Why do traders use weighted average tools? They do it so that they can generate all sorts of trading signals. 

To give an example, once that price action moves to or beyond that WMA, it might be time to start exiting your trades because the market may take a turn for the worse.

Obviously, the opposite will be true if the price goes below that WMA. Not only that, but since it’s like an average of the stock’s prices, it can help with smoothing out some of that data on the chart.

Also, using the WMA instead of the SMA, or simple moving average, can be a more accurate way of determining trend direction, largely because the SMA allocates equal weighting to every number within the data set.

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How is the WMA Calculated?

How is the WMA calculated then? Firstly, when you’re calculating it, like we said earlier, you should assign recent data points with greater weighting and past points with lower weighting. 

Naturally, the figures within the data set will come with distinct weights, relatively speaking. So, the sum of those weights should be equal to either 1 or 100%.

As for how you can go about calculating those values, it mainly boils down to four steps. 

First would be to find out those numbers you wish to average, then determine, for yourself, the weight of every number, multiply every number with the weighting factor, and finally, make a total of all the resulting values to acquire the weighted average. 

But we’ll look a bit more deeply into all that below.

WMA Formula

So, the first step is to generate an entire list of numbers for which you wish to identify the weighted average. 

In this example, we’ll simply use the closing prices of a certain stock that it hit in the last five days.

After you’ve identified the numbers to use within your calculation of the weighted average, next, you’ll need to find out the weight of every number. 

The equation or formula that we’re using to weight every number would be the number of that day divided by the total of every day number. 

Since we’re using five days within our example, the sum of every day number is 15, i.e., 1+2+3+4+5. The greatest weighting would obviously be given to the latest data point, i.e., the most recent day, with a weighting of 5/15, with the preceding day’s being 4/15, and so on and so forth.

The third and fourth steps are to basically multiply every one of those numbers, or rather closing prices, by their corresponding weighting factor and then add all of those resulting values together. 

And there you go. Here is how the weighting average is determined.

Key Parameters of WMA

So, the key parameters based on what we went over earlier would have to be the weighting of the numbers themselves and how many periods or days are being used. 

Both are integral to the calculation of the weighted moving average, after all, and you can’t do it without them.

How to Use WMA in Trading

Now that you have a fair idea of what the weighted moving average is supposed to be, you might want to shift your attention to how you may use the indicator within your trading endeavors.

Trend Following with WMA

The first and obvious way to trade using the WMA would be to follow trends, and given the WMA indicator’s nature, the lag might not be as much, and you can filter out the market noise too.

With this, you may get a better or clearer idea of whether the market is trending upwards or downwards, or whether it is flat or has been flat for a certain period.

WMA Crossovers

The second and probably the most useful way to use it within your trading would be implementing crossovers. Here, you have to choose two WMAs of varying lengths. 

Traders typically use the 50-WMA and 100-WMA, as those are known to be effective. After that, traders could then look for when that short-term WMA crosses above the longer-term one, which they may use as a signal to determine bullish or bearish crossovers. 

So, a bearish crossover occurs when the shorter WMA crosses below the longer one, and with the exact opposite, a bullish crossover happens.

WMA and Price Action

Previously, we went over a bit of the price action and what it means when price either crosses above or below the WMA. 

To reiterate, if the stock’s price goes above its WMA, then it might be the time to start exiting whatever positions you’re holding, but if it goes below the WMA, then that could be the time to enter a trade or open positions, since it could be an indication that prices have bottomed and that they may go up now.

WMA Strategies for Different Trading Styles

The number of trading styles that you can use in your stock trading practices is numerous. However, if you were to mention the most often used styles, then it would boil down to day, swing, and long-term trading, which is why we’ll discuss how WMA can relate to each of them.

Day Trading with WMA

If you’re a fan of day trading and you want to use the WMA indicator, then you can adjust the time frames accordingly, i.e., make them shorter so that you could make some of those short-term gains.

A rather popular day trading strategy that you could employ would be scalping, which involves making considerable trades in relatively short spans of time, all to maximize that profitability.

Swing Trading with WMA

But if it’s swing trading that you prefer, which revolves more around medium-to-long-term profitability, then you can change the time frames for the WMA indicator to reflect your requirements. 

And since you have more time to work with when compared to day traders, you might be more advantaged from crossover strategies, which typically take a while to form.

Long-Term Investing with WMA

But what if you are someone who prefers to take a more long-term approach to his or her trading? Well, luckily for you, there are plenty of ways for you to take advantage of the WMA. 

You can start by shifting those time frames to make them more aligned with your goal. After that, you can use it for trend confirmation, price action, crossovers, and whatnot.

Advantages and Limitations of WMA

Like any indicator out there, WMA has its fair share of drawbacks or limitations coupled with those benefits. So, let’s look into them now.

Benefits of Using WMA

To begin with the advantages, you have the fact that it’s more responsive to price changes compared to some of the other lagging indicators out there, like SMA. 

But while it is more responsive, it’s smoother too and can filter out some of the market noise that may hinder decision-making. Not only that, but it can work across various time frames, so it’s quite flexible, and that’s always a good thing.

Limitations of WMA

But on to the limitations now. Firstly, no matter how fast it may be, at the end it’s still a lagging indicator, and that comes with its own set of implications. 

Then there’s the potential for false signals too, particularly within choppy markets. Additionally, it’s more complex too when compared to SMA, and that could deter some people.

Conclusion

The WMA, with how it emphasizes the latest data points, has pulled many investors into using it in their trading efforts. 

However, while it’s good to note the positives, such as more responsiveness, smoother charts, etc., you can’t just gloss over its limitations too, like the fact that it’s a lagging indicator, as knowing those is just as important if you are to make the most out of it.