A moving average that gives bars with large volume more weight than bars with light volume is called a volume weighted moving average. As a result of being volume weighted, the moving average’s value will be more in line with where the majority of trading really took place.
Almost all moving average types can be adjusted for volume. A moving average that is both front weighted and volume weighted, an exponential volume weighted moving average, a simple volume weighted moving average, or even a volume weighted moving linear regression are all possible.
Applying the moving average (of whatever type) to both price (or whatever else is being averaged) times volume and to just volume by itself is the fundamental computation. The volume weighted moving average is then calculated by dividing the moving average of price times volume by the moving average of merely volume.
What is volume weighted moving average (VWMA)?
The volume-weighted moving average, often known as VWMA, is very similar to a standard moving average, as its name suggests. The VWMA also considers volume, giving close prices that form under large volume more weight than close prices that form under low volume, which is the primary distinction.
The volume-weighted MA is based on the idea that price changes that take place during periods of high volume are more meaningful than those that take place during periods of low volume. As a result, it is believed that including volume in the equation will result in an MA-line that is more accurate.
The WVMA and simple moving average will typically display numbers that are pretty comparable. This could, however, alter significantly when the volume is variable and some days have significant outliers. For instance, it’s pretty typical to observe how markets are thrown around and how low and high volume days follow one another during periods of extreme volatility. The Volume Weighted Moving Average might diverge from the SMA in those circumstances.
How is the VWMA calculated?
Although the Volume Weighted Moving Average has more components than a plain, simple moving average, it is still very simple to compute. You multiply the recent close prices by volume instead of simply averaging all the recent close prices.
Therefore, to create a simple moving average of the last two bars, perform these steps:
SMA equals (This close plus the prior close)/2
You would perform the following steps to determine the volume-weighted moving average:
VMWA is defined as (current close*volume + prior close*volume) / (current bar volume + prior bar volume).
As you can see, it is still straightforward and simple to memorize.
VMWA strategies
You may now be curious about how traders go about incorporating VWMA into their own trading methods. Moving averages can be used in a variety of ways, and the VWAP implementations aren’t all that dissimilar from how traders typically go about using similar moving averages. Again, the VWMA may be more appropriate for various markets, timeframes, or trading techniques.
You must conduct some backtesting on past market data to determine the kinds of strategies and marketplaces that complement the VWAP. You’ll gain a better understanding of what has produced results in the past and is most likely to do so in the future.
Trend following
Like all other moving averages, the VWMA can be used to track the trend. The indicator is added here, and you can use it to determine when to leave. Many traders employ various time frames for this, but we favor the 50-day WMWA.
For instance, the price of Bitcoin is in a positive trend, as shown in the chart below. The currency continues to strengthen while staying above the 50-day VWMA. As long as it is higher than this average, traders maintain their positions in this scenario. Any time the coin drops below the indicator, an exit point becomes apparent.
Crossover Trading Strategy
The crossover signal is likely the most typical kind of moving average signal. It happens when a shorter-term average crosses over a longer-term average, to put it briefly.
As seen in the graphic above, a signal known as a “golden cross” is produced when the 50-period moving average crosses over the 200-period moving average.
Now, one intriguing variation on this well-worn tactic is to use a volume-weighted average in place of the short-term SMA. In this manner, you may rely on both the strength of each price move and the direction of the price itself. As a result, there is a possibility that this combination would produce fewer false signals than if simply simple moving averages were used.
Breakouts
Breakout trading is a kind of trading where you try to capitalize on significant price changes and anticipate them to continue moving in the momentum’s direction. Breakout traders typically monitor specific levels of support or resistance and trade breakouts above or below these levels. Typical breakout levels include:
The pivot points with the highest high or lowest low
Averages of movement (such as the VWMA)
Many traders use long-term moving averages, such as the 200- or 100-period moving averages, when using moving averages. As a result, they aim to buy when the market breaks above the average and sell when it does the opposite.
With the Volume Weighted MA, however, we may take a somewhat different strategy to breakout trading because it takes volume into account. When you use a VWMA and a SMA with the same periods, your lines will typically be fairly similar to one another. The VWMA will, however, occasionally experience a dramatic surge or decline in relation to the SMA.
A sharp rise in the indicator line indicates that recent up days have had significantly more volume than recent down days, keeping in mind the VWMA’s methodology and properties. Therefore, you may claim that the VWMA has strayed from the SMA.
An ideal illustration of this can be found in the picture below. A significant gain in prices is followed by a sharp upward movement of the VWMA, which indicates that volume is strongly bullish.
Reversion to the mean (Mean Reversion Strategy)
A trading strategy called mean reversion looks to capitalize on the common characteristics of mean-reverting markets. A price swing in the other way results from prices tending to overextend themselves both upwards and downwards, which is what it essentially means. As mean reversion traders, our goal is to make money off of this counter-reaction, or reversion to the mean.
In mean reversion methods, moving averages can be a key component of the main exit or entry mechanism or act as a filter to help the approach only be activated when the odds are at their best.
For instance, many swing trading methods only buy when the market is above its 200-period moving average and go long at oversold levels. In other words, it only goes long when the expected bullish price swing is supported by the long-term trend.
Moving averages are frequently used in mean reversion trading to calculate the separation between the close and the MA. When it hits a predetermined percentage, it is thought that the market has oversold and will soon begin to recover.
Another popular strategy is to set a profit objective using a reasonably short MA, such as five to ten periods. Since most long transactions are executed after the market has declined, it stands to reason that the close will almost certainly be below the short-term average.
In general, mean reversion trading can employ volume-weighted moving averages just like conventional moving averages. Just be aware that the outcomes won’t be exactly the same as what you would obtain from a simple moving average. Depending on the market, this may or may not be advantageous.
Is the VWMA better than the EMA?
The methods used to calculate the VMWA and the exponential moving average are different. For starters, Volume weighted moving average employs both volume and the simple moving average.
However, the EMA, a particular sort of moving average, minimizes the noise by emphasizing more recent data. For instance, you should start emphasizing today going backwards while computing the EMA for a 20-day period.
When applied on a chart, the two still have the same appearance. The two are also utilized similarly by traders. A chart with a 50-day EMA and 50-day VMWA is displayed below.