A:

Moving averages are one of the most popular tools used by active traders to measure momentum. The primary difference between the simple moving average and the weighted moving average is the formula used to create them. For a simple moving average, the formula is the sum of the data points over a given period divided by the number of periods. For example, the closing prices of Apple Inc (AAPL) from June 20-26, 2014 were as follows:

Date

Closing Price of AAPL

June 26

$90.90

June 25

$90.36

June 24

$90.28

June 23

$90.83

June 20

$90.91

A 5-period moving average, based on the prices above, would be calculated using the following formula:

(P1+P2+P3+P4+P5)/5

P = Period

($90.90+$90.36+$90.28+$90.83+$90.91)/5 = $90.656

Based on the equation above, the average price over the period listed above was $90.66. Using moving averages is an effective method for eliminating strong price fluctuations. The key limitation is that data points from older data are not weighted any differently than data points near the beginning of the data set. This is where weighted moving averages come into play.

Weighted averages assign a heavier weighting to more current data points since they are more relevant than data points in the distant past. The sum of the weighting should add up to 1 (or 100%). In the case of the simple moving average, the weightings are equally distributed, which is why they are not shown in the table above.

For example:

Date

Closing Price of AAPL

Weighting

June 26

$90.90

5/15

June 25

$90.36

4/15

June 24

$90.28

3/15

June 23

$90.83

2/15

June 20

$90.91

1/15

The weighted average is calculate by multiplying the given price by its associated weighting and then summing the values. In the example above, the weighted 5-day moving average would be $90.62.

Calculation

((90.9*(5/15))+(90.36*(4/15))+(90.28*(3/15))+(90.83*(2/15))+(90.91*(1/15)))

In this example, the recent data point was given the highest weighting out of an arbitrary 15 points. You can weigh the values out of any value you see fit. The lower value from the weighted average above relative to the simple average suggests the recent selling pressure could be more significant than some traders anticipate. For most traders, the most popular choice when using weighted moving averages is to use a higher weighting for recent values. (For more information, check out the Moving Average Tutorial)

 

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