Trade With Weighted Moving Average
What is Weighted Moving Average
The Weighted Moving Average indicator, sometimes also referred as WMA, is another technical chart indicator based on moving averages, that tracks the price movement of an instrument over time. WMA is a weighted moving average indicator and it gives more importance to recent price data, when compared to a simple moving average. This is done by multiplying each bar’s price by a weighting factor. The WMA indicator will follow prices more closely than a typical simple moving average precisely because of this weighting factor.
How Does Weighted Moving Average Work
The Weighted Moving Average indicator averages the past prices of an instrument using a weighting approach to emphasize more on the recent price action rather than past price activity. In contrast to a simple moving average, where all prices are treated equally, recent price changes play a much larger role in the calculation of the Weighted Moving Average results compared to older data. Weighted Moving Averages are used to identify trends and reversals, as well as to outline important support and resistance levels.
To add an Weighted Moving Average indicator in Fondex cTrader, follow the steps below:
1. Right Click on the chart and navigate to Indicators > Weighted Moving Average
2. Click on the Weighted Moving Average indicator and the following will pop up
3. Select Source, Periods and Shift and click OK. The indicator will be plotted on your chart
The formula to calculate a Weighted Moving Average is pretty straight forward. We can see the equation used for the calculation of the WMA indicator below
Weighted Moving Average Strategies
There are many ways to use Weighted Moving Averages to interpret and understand trending markets, as well as to anticipate trend reversals. Identifying important support and resistance levels is another major use of the indicator. This is because recent prices play a much more important role in the calculation of the WMA values. WMA indicators are particularly sensitive to recent price changes, especially when compared to a typical simple moving average indicator, therefore they are a preferred indicator when it comes to identifying price reversals, breakouts and new trend formations. In the sections that follow, we will highlight some of the most popular Weighted Moving Averages strategies used in trading.
WMA Golden Cross and WMA Death Cross
The golden cross and death cross strategy is one of the most popular and simple ways to use Weighted Moving Averages in trading. This strategy uses a combination of two WMA indicators plotted on the chart. A golden cross occurs when a faster - 50 period Weighted Moving Average crosses over a slower - 200 period Weighted Moving Average from below, and a death cross occurs when a faster - 50 period Weighted Moving Average crosses over a slower - 200 period Weighted Moving Average from above. Below we can see two examples, one of an WMA golden cross and one of an WMA death cross, taken from Fondex cTrader charts.
A golden cross between the two WMAs is usually associated with the formation of a bullish trend. The trend is defined by the short-term WMA, while the long-term WMA indicates a strong resistance level. In the scenario above, the short-term WMA has reversed direction, and as soon as it crosses the longer-term WMA from below, breaking the resistance level, we have an indication that higher prices may follow. See an example below. The short-term WMA is depicted in red and the long-term WMA in blue.
On the opposite side, a bearish trend formation is signaled where a death cross between the two WMAs might be the signal for the formation of a bearish trend. Again, the short-term WMA serves as a trend direction indicator, but in this case the long-term WMA may identify a support level. In the death cross scenario below, the short-term WMA has taken a downwards path and as soon as it crosses the longer-term WMA from above, breaking the support level, we have an indication that lower prices might be expected.
Weighted Moving Average ribbons are a collection of Weighted Moving Averages of different lengths that are added on the same chart to form ribbon-like indicators. WMA ribbons are used to evaluate the strength of a trend. The strength of the trend is determined by looking at the distance between WMA indicators. The wider the distance between the WMA indicators, the more strength the trend might gain. WMA ribbons are also used to identify key areas of support or resistance by looking at the price in relation to the ribbon. Finally, WMA ribbons could be used to signal potential trend changes when the price moves through the ribbons, or the ribbons cross each other. Below we can see an example of WMA ribbons plotted on Fondex cTrader.
Three WMA Crossover Strategy
The three WMA crossover strategy could be considered as another popular trading strategy consisting of three WMA indicators plotted on the chart. The most usual setup consists of a short-term WMA at 9 periods, a medium-term WMA at 21 periods, and long-term WMA at 50 periods. The Triple WMA crossover strategy signals a buy as soon as the short-term WMA is higher than the medium-term WMA and the medium-term WMA is higher than the long-term WMA. When the short-term WMA is back below the medium-term WMA, the strategy signals an exit from the position. The opposite is true for short trades. Below we can see some examples of buy and sell signals using the three WMA strategy.
In the chart above, we can observe that as soon as the 9 and 21 period WMA indicators cross below and above the 50 period WMA indicator - a trend towards the respective direction is formed, confirming the validity of the respective signals.
Limitations of the Weighted Moving Average
The Weighted Moving Average indicator, just like any other technical indicator, needs to be used in context. WMA indicators can generate a lot of false signals that could lead to substantial losses if used out of context. Therefore, when using WMA indicator strategies, always consider the fundamentals that currently move the market and combine the signals with other confirmation signals, such as oscillators, support/resistance levels and the relevant price action taking place on the chart.
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