What is Weighted Moving Average? When should I use it?

 

What is Weighted Moving Average?

A Weighted Moving Average (WMA) puts more weight on recent data and less on past data. This is done by multiplying each bar’s price by a weighting factor.

 

How does Weighted Moving Average work?

• Use the WMA to help determine trend direction. It could be an indication to buy when prices dip near or just below the WMA. It could be an indication to sell when prices rally towards or just above the WMA.
• WMA, are not designed to identify a trade at the exact bottom or top. Moving averages tend to validate that your trade is in the general direction of the trend, but with a delay at entry and exit.
• WMA is generally more sensitive to price movement. This can be a double-edged sword. On one side, WMA can identify trends sooner than a Simple Moving Average. On the flip side, the WMA will probably experience more whipsaws than a corresponding SMA.

 

How to calculate Weighted Moving Average?

The most recent data is more heavily weighted, and contributes more to the final WMA value.

The weighting factor used to calculate the WMA is determined by the period selected for the indicator. For example, a 5 period WMA would be calculated as follows:

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

Where:
P1 = current price
P2 = price one bar ago, etc…

Weighted Moving Average can be less than 5 days, 10 days, 20 days or any days you would like to define, when you pick the period, for example 2 days, meaning you are more interested in short term price movement, if you choose 20 days period WMA, meaning you are more interested in mid-term trend. If you choose 20 days, the formular goes as below

WMA = (P1 * 20) + (P2 * 19) + (P3 * 18) + (P4 * 17) +...........  (P5 * 1) / (10 + 19+ 18 + 17 + ............1)

 

Example how to use Weighted Moving Average to analyze Twitter stock

Elon Musk bought Twitter has been hot news recently, first he bought 9% twitter stock, joined board of Twitter, just after a few days, he claimed to buy entire Twitter, which caused batter between him and board of Twitter, on April 25th, dust settle down, Twitter Board accept his offer of 44 Billon of buying Twitter

 

Since Elon Musk announced his initial decision, Twitter stock soared from 39 dollar to 49 dollar on April 4th, and since then Twitter stock is one of most active trading stock, trend indicator Weight Moving Average reflected this momentum.

 

Below is Twitter Stock Price and its 5 days Weighted Moving Average trend

Green color represents 5 days WMA, green color represents 20 days WMA, it is obvious that both lines catch Twitter stock price movement trend, however 5 days WMA is more sensitive to the price movement, especialy during stock price in its volatility phase.

If you are active day trader, 5 days WMA could help you to decide when to buy or sell. Just like any investment decision, you should view more indicators before making investment decision.