Good day everybody,
Welcome to CryptoGod-1's blog on all things crypto. Today we are going to continue the series on Technical Analysis and why it can be such an important asset for new or experienced traders. In this series I am covering some of the different Technical Analysis and Indicators which can be used to help determine market movement and sentiment when trading. For Part XXII the focus will be on Weighted Moving Average.
Weighted Moving Average
A Weighted Moving Average (WMA) is an indicator used by traders to generate trade direction to assist in making buy or sell decisions. It assigns a greater weight to the recent data and less to the past data when calculating the average. This is done by multiplying each observation in the data set by a predetermined weighting factor. The weighted moving average is used for trade signals, often depending where the WMA line is on the candlestick chart compared to the price action. Therefore the WMA is used to determine trend direction and can be considered more accurate than a traditional simple moving average (SMA), as the SMA assigns identical weights to all numbers in the data set.
Calculating the Weighted Moving Average
To calculate the Weighted Moving Average the recent data points are assigned a greater weighting, whereas past data points are assigned less weighting. It is used when the figures in the data set come with different weights, relative to each other. The sum of the weight should be equal to 1 or 100%.
The first step is in creating the list of numbers for use in the WMA. An example would be taking the closing price of an asset over five days.
The second step is assigning a weight to each number. This is weighted out of the overall sum, so if its five days, the weights will be out of 15 (because 5 + 4 + 3 + 2 + 1=15) The weights will be assigned as follows:
Date Closing Price Weighting Day 1 $91 1/15 Day 2 $90 2/15 Day 3 $89 3/15 Day 4 $88 4/15 Day 5 $90 5/15
The third step is to multiply the weight of each number by the closing price, and to to apply the Weighted Moving Average formula, as shown below:
Date Closing Price Weighting Weighted Average Day 1 $91 1/15 $6.07 Day 2 $90 2/15 $12.00 Day 3 $89 3/15 $17.80 Day 4 $88 4/15 $23.47 Day 5 $90 5/15 $30.00
Where:
- N is the time period
Finally, the final step is to add up the resulting values to get the Weighted Moving Average:
WMA = $30.00 + $23.47 + $17.80 + $12.00 + $6.07
WMA = $89.34
Another, perhaps simpler way of writing/understanding the formula, would be:
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
How to use the Weighted Moving Average
The WMA is used to help determine the trend direction, and therefore traders can use it as an indication to buy when prices drops near or just below the WMA, while also using it as an indication to sell when prices climbs towards or just above the WMA.
WMA can also be used to outline where support and resistance areas are. When the WMA is rising, the WMA line tends to act as a support for the price action of the asset, while when it is falling, the WMA tends to act as a resistance level for the assets price. This strategy reinforces the idea of buying when price is near the rising WMA or selling when price is near the falling WMA.
When considering a WMA, similar to all moving averages, it is not designed to identify a trade at the exact bottom or top. While Moving averages tend to validate that your trade is in the general direction of the trend, it does so with a delay. The WMA is done with a shorter delay than the traditional SMA.
The WMA is also more sensitive in general to price movement that a traditional SMA, even though the same rules for trading can be applied. Traders should be aware that this can be a double edged sword. On one side of it, WMA can often identify trends sooner than a SMA will. On the flip side of that, the WMA will likely experience more whipsaws than a corresponding SMA, making it difficult for a trader to identify the right moments to trade.
The main types of trading strategies with the WMA are the Golden and Death Crosses, Ribbons, and Crossovers.
Golden and Death Crosses
The Golden and Death Crosses are concepts well known by traders who make use of moving averages. It involves the use of two, or more, Weighted Moving Averages, with one generally being a 200 period which is the slower moving average, and the other being a 50 period, which is the quicker moving average.
The death cross occurs when the 50-day WMA crosses below the 200-day WMA, and it is considered a bearish signal. This is considered a bearish signal. The short-term WMA serves as a trend direction indicator, and the long-term WMA can be used to identify a support level. With the death cross scenario, the short-term WMA changes towards a downwards path and as soon as it crosses the longer-term WMA from above, it breaks the support level and gives the indication that lower prices can be expected
The golden cross occurs when the 50-day WMA crosses above the 200-day WMA, and it is considered a bullish signal. This is considered a bullish signal. The trend is defined by the short-term WMA, while the long-term WMA indicates a strong resistance level. The short-term WMA has reversed direction, meaning as soon as it crosses above the longer-term WMA from below, it will be breaking the resistance level. Therefore it is an indication that higher prices may follow.
Below is an example of a Golden Cross (top image) and a Death Cross (bottom image), gotten from fondex.com
Ribbons
A WMA Ribbon strategy is a collection of WMA using different periods, all added to the same chart. The multiple WMA's create a ribbon like pattern on the chart, which can be used to evaluate the strength of a trend. This can be determined by looking at the distance between WMA indicators. The wider the distance between the multiple 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 is an example of Ribbons, gotten from fondex.com
Crossovers
Finally, the WMA crossover strategy is a very popular trading strategy when it comes to using the WMA. It consists of three WMA indicators plotted on the chart. The most common ones are set at a short-term WMA at 9 periods, a medium-term WMA at 21 periods, and long-term WMA at 50 periods.
The strategy basically signals a buy as soon as the short-term WMA is shown as higher on the chart than the medium-term WMA, while at the same time the medium-term WMA is higher than the long-term WMA. Once the short-term WMA moves back below the medium-term WMA, it is an indication to close the trade.
The reverse applies to show a sell signal, when the short-term WMA is below the medium-term WMA, and the medium-term WMA is below the long-term WMA. Once the short-term WMA moves back above the medium-term WMA, it is a signal to close the short trade.
Below is an example of Crossovers, gotten from fondex.com
Limitations of Weighted Moving Average
The WMA and SMA work in a similar fashion, therefore their limitations are also similar. The WMA rely heavily on the most recent prices and place less value on older prices. Due to the fact that WMA's are lagging indicators it is considered a major drawback as they suffer from a time lag, generating a false signal. The WMA is more effective at reducing the effects of lags in data but it is still a lagging indicator. This means an assets price may move sharply before a WMA can respond to show the change in trend. A shorter moving average suffers from less lag than a longer moving average. These lags can also be used in a beneficial way as traders make use of technical indicators know as the death cross and golden cross with these lagging indicators crossing over, as mentioned above.
Conclusion on using the Weighted Moving Average for TA
As a trader, whether it be day trading or long term trading, using Weighted Moving Average can be very beneficial in determining trend direction when an asset is in a position to be bought or sold condition. Weighted Moving Average is similar to the traditional moving averages, but it is done by multiplying each observation in the data set by a predetermined weighting factor to get a definitive value, which is placed on the chart. This makes the WMA more accurate than the SMA, as the SMA applies the same factor weight to all values. As the chart progresses the WMA forms a line, which can be used by traders to identify the trend strength and direction, along with being an indication of support and resistance levels. It does however have a more sensitive reaction to price movement than a traditional SMA, making it a double edged sword. Therefore the Weighted Moving Average should not be used as a standalone indicator, instead it should be used in conjunction with other indicators to give stronger results and more reliable signals, especially trend indicators.
As stated whether you are experienced or new, Technical Analysis can always be a useful asset when trading. Just remember it is not guaranteed and nobody can predict the future, no matter how certain you believe the patterns to be. It is always just another tool of the trade to help make more informed decisions when trading. It can be easy to get caught into false signals with the sensitivity of the Weighted Moving Average, making you close or open a trade early. The benefit is it will be much more up to relevant speed than a traditional SMA. It should always be used as an indicator and not as a definitive, as the price can always cross the WMA no matter how much of a support or resistance level you believe there to be.
It is important to use the Weighted Moving Average along with other TA to get the correct signals for understanding the strength and direction of a trend. Always zoom out, if trading on a 15 minute chart check the 1 hour or 4 hour or even 1 day chart to give you a better idea of the overall trend strength and direction via the Weighted Moving Average, along with checking the trend strength of the larger overall trend compared to short term ones.
You can find the previous parts to the series here:
Technical Analysis - Part I - Exponential Moving Average (EMA)
Technical Analysis - Part II - Relative Strength Index (RSI)
Technical Analysis - Part III - Bollinger Bands (BB)
Technical Analysis - Part IV - Moving Average Convergence Divergence (MACD)
Technical Analysis - Part V - On-Balance Volume (OBV)
Technical Analysis - Part VI - The Average Directional Index (ADX)
Technical Analysis - Part VII - The Aroon Indicator
Technical Analysis - Part VIII - The Accumulation/Distribution Indicator (A/D)
Technical Analysis - Part IX - The Supertrend Indicator
Technical Analysis Part X - Parabolic SAR Indicator
Technical Analysis Part XI - Support & Resistance Levels
Technical Analysis Part XII - Fibonacci Retracement Levels
Technical Analysis Part XIII - The Awesome Oscillator
Technical Analysis Part XIV - The Arnaud Legoux Moving Average
Technical Analysis Part XV - Ichimoku Cloud
Technical Analysis - Part XVI - Footprint Charts
Technical Analysis - Part XVII - Heikin Ashi Candlesticks
Technical Analysis - Part XVIII - True Strength Indicator
Technical Analysis - Part XIX - The Klinger Oscillator
Technical Analysis - Part XX - Connors RSI
Technical Analysis - Part XXI - Coppock Curves
Also feel free to check out:
I hope this post was beneficial and of some use, and I plan on continuing the series with the next instalment focusing on the triple exponential average, also known as the TRIX indicator. Of course each technical analysis provides different beneficial information, so combining your most trusted and favourite ones can be the best strategy for finding entry and exit points when trading.
Have a great day.
Peace. CryptoGod-1.
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