The Advantages of Weighted Moving Average

When researching investments, one of the most useful technical price-action indicators is the weighted moving average. A moving average takes a series of previous closing prices, adds them together, and divides it by the number of days in the given period of time. The result is a trend indicator that shows the general price direction without the extreme volatility that can distort your reading. A weighted moving average changes the formula to make it more useful.

Moving averages cover a specific period of time: 10, 20, 50, 100 or 200 days. They appear as a simple line that rises or falls with the general direction of the price. In a common technique of technical analysis, short- and long-term moving averages are superimposed over a price chart. A short-term moving average crossing over a long-term moving average may indicate a new price trend, or a change in direction. Many traders use this crossover as a buy or sell signal.

A simple moving average assigns equal weight to all the closing prices used in the calculation. In a 20-day simple average, the price on the first day is assigned the same importance as the price on day 20. The prices are added together and the number is divided by the number of days in the period to arrive at the figure, which is then rendered on the price chart.

A weighted moving average assigns the closing prices a factor related to how recent they are. The more recent the price, the more weight it has in the calculation. Thus, the weighted moving average is a more accurate measure of recent price action -- information that is more useful for many traders than a simple moving average.

Many trading platforms allow you to adjust a weighted moving average. By changing the weight to change the importance to recent prices, you can develop your own trading system. There are no magic formulas or systems that reliably predict stock prices. The most useful system is one that you develop on your own and that draws on your personal preferences, outlook on investments and abilities.