Moving average is the most common technical indicators in the trading world. If you watch financial television or read financial content, you have likely heard the commentators and analysts talk about it.
We have covered moving averages in the past. In our past article, we guided you on how to calculate the averages and how to use them in the market.
The concept of Volume in Trading
Volume is another important concept in the financial market. Traders use this concept to identify the strength of a trend.
In her book, A complete guide to volume price analysis, Anna Couling writes that volume is the key foundation to any trader’s success.
A good way to look at this is to consider an example of a stock. The stock price of company A can soar by 20% today. If this price action is not supported by most traders, the price will mostly come back lower in the following day.
What is the VWMA, Volume Weighted Moving Average
In this report, we will look at the volume weighted moving average (VWMA), an indicator that combines the concept of moving averages and volume. We will look at how it is calculated and how you can use it in the market.
How it is Calculated
In our previous article on moving averages, we found that the process of calculating a simple moving average is relatively easy. You just take the closing prices of an asset, add them, and then divide by the number of periods.
The volume weighted moving average is relatively different because it considers the volumes.
Here are the steps you have to follow:
- First, you need to calculate the typical price of an asset in a day. You do this by adding the asset’s highest, lowest, and closing level, and then divide the number by three.
- The second step is where you multiply the answer you got in the first step by the period’s volume. You then do this for all the periods that you are covering. After this, you add these values, which is known as the cumulative total.
- In the next step, you add the total volume and in the final step, you divide the running total price and the volume.
In summary, you can calculate the VMWA using the following formula.
|VMWA = (C1*V1 + C2*V2 +C3*V3) / (V1 +V2+V3)|
This is a VMWA for a three-day period.
As you can see, the process can be relatively long. However, as we have always mentioned, you don’t need to learn about this. As a trader, your goal should always be focused on learning about how to use the indicator.
VMWA strategy: how to trade with this indicator
The VMWA is used in a similar way to the normal moving average. There are many ways of using the VMWA. However, our best strategy is one that combines a longer and a shorter-dated VMWA.
By combining the two, you are able to identify good entry and exit positions.
When you combine a shorter and a longer-period VMWA, you should watch out for where they crossover. When the price is in an uptrend and the shorter and longer-term VMWAs make a crossover, it is usually a signal to sell. The vice versa is also true.
An Example in Charts
The chart below shows the stock price of Apple. On this chart, we have used a 10-day and 20-day VMWAs. As you can see using the blue arrow, the price of Apple reversed when the two reversed.
Also, the red arrows show that the price moved higher when the two lines made a crossover.
Advantages of the Volume Weighted Moving Average
There are two main advantages of the VMWA. First, the indicator is very easy to use as you can see above. Second, the indicator improves the moving average, which is a popular indicator by introducing volume.
The main disadvantage is that it is not found in most trading platforms. As such, you must download it and install manually, which is a difficult thing to most people.
VMWA is a great indicator to use to identify reversals and confirm a trend. As a trader, we recommend that you take time to learn how the indicator works. Also, we recommend that you take time to practice more using a stock market simulator before you use it in your live account.