Weighted Moving Average (WMA): Formula and How It Works

The weighted moving average (WMA) is a simple moving average that places more emphasis on the most recent data points because they carry more relevance than older data points. Each data point is multiplied by its own weight and the results are summed, then divided by the number of periods. The weighting is set by the number of points chosen.

The sum of the weights must add up to 100 percent.

However, the weights are distributed so that, for example, in a 10-day weighted moving average the oldest closing price is weighted at only 7% while the most recent closing price is weighted at 33%.

The WMA can be used with any price, including the open, close, high, or low, and it can also be combined with other technical indicators.

This moving average works to smooth the data series, which is important in a volatile market because it helps traders identify trends more easily.

How the Weighted Moving Average Is Calculated

The idea behind weighted moving averages is that recent prices are more relevant when trying to gauge where prices might move next. Calculating the weighted moving average involves three steps.

First, you need to choose the period of the weighted moving average to be calculated.

Second, calculate the weight that will be assigned to the prices.

Finally, calculate the weighted moving average using the following formula.

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

Where: P1 = the current price

P2 is the price before that, and so on.

In short, the weighted moving average = (sum of weighted averages) / (sum of weights).

Example

Let’s say we want to calculate the estimated moving average for five stock prices over a seven-day period.

The prices are $20.25, $26.39, $28.91, $31.52, $29.32, $25.43, and $24.65, with the last price being the most recent.

Since we have the prices we want to average, the next step is to assign a weighting to each price based on how recent it is and the specified period.

We then multiply each of the seven closing prices by its weighting factor to find the weighted average.

Next, add up each of the individual weighted average values to get the weighted moving average.

The weighted moving average of the five stock prices over the seven-day period is $29.40.

The WMA indicator appears as a line directly on the price chart as shown above. If the line moves above price action, this indicates a downtrend, while the line moving below price indicates an uptrend.

Using WMA to Make Trading Decisions

The weighted moving average is often used to filter out noise (i.e., smooth irregular fluctuations) in a time series, allowing traders and chartists to better spot trend patterns over time.

Traders use WMAs in the same way and for the same purpose as other moving averages.

But the advantage of the weighted moving average is that it gives earlier and stronger signals of a trend reversal and its direction, because it focuses on more recent price data.

Here are a number of ways day traders can use the weighted moving average.

• To help gauge price movement: the WMA generally reacts faster to price movement, which makes it a more responsive measure and lets it spot potential trends sooner compared to the simple moving average.
• To identify trading signals: the weighted moving average can also be combined with other technical tools to give more precise trading signals.
• To determine the trend: when the price is below its WMA line, this is usually a sign that, on average, the stock is trading lower than it was during the period being analyzed, which in turn confirms a downtrend.

On the other hand, when the price is above the weighted moving average line, it confirms an uptrend.

• To check market momentum and price strength: price action below its moving average shows the market has become weaker compared to the past, since more recent prices are now below the average. Price action above its moving average, on the other hand, shows the market is getting stronger compared to the past.
• To signal resistance and support zones: a rising weighted moving average can indicate support for price action during a given period, while a declining weighted moving average can indicate resistance to price action.

This is a strategy commonly used by traders to place sell orders when price approaches a declining moving average, or to place buy orders when price approaches a rising weighted moving average.

Bottom Line

Most day traders agree that technical indicators are at the center of any trading strategy.

Although there are many types of indicators traders can use in chart analysis today, the weighted moving average remains one of the most common.

The weighted moving average gives more importance to more recent price values, so it reacts faster to price changes than simple moving averages. WMAs also tend to stick with the trend.

But as with other technical analysis tools, you need to know how to use and interpret the weighted moving average to get the best possible results in your trading.

Frequently Asked Questions

What is the golden cross?

A golden cross happens when a short-term moving average crosses above a longer-term major moving average in an uptrend, and analysts and traders read it as signaling a possible bullish shift in the market. In essence, the short-term average rises faster than the long-term average until the two cross.

What is the SMA?

It’s simply the average price over a specified period. It’s called “moving” because it’s plotted bar by bar on the chart, forming a line that moves along the chart as the average value changes.

What does EMA stand for?

The exponential moving average (EMA) is a technical chart indicator that tracks the price of an investment (such as a stock or commodity) over time. The EMA is a type of weighted moving average (WMA) that gives greater weight or importance to more recent price data.

What does “moving average” mean?

A moving average is a statistic that captures the average change in a data series over time. In finance, technical analysts often use moving averages to track price trends for a given security.

What’s the difference between the simple and exponential moving average?

The exponential moving average (EMA) is similar to the simple moving average (SMA) in that it measures the direction of the trend over a period of time. However, while the SMA simply averages the price data, the EMA applies greater weight to more recent data.

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