4.10 Weighted and Exponential Moving Averages Comparison

 

weighted moving average versus exponential moving average? Well, aren't they both are weighted? Yep, you got that right. Both WMA and EMA are weighted averages. The difference is that WMA puts linearly decreasing importance to the closing prices as we move back into past, while in the case of the importance or weights decrease exponentially. The most recent price-action has the highest importance in both cases.

 

Difference between importance of old prices in WMA and EMA calculations.

 

These is another important distinction which is as follows:

 

WMA is calculate in the similar way as the SMA as far as various data points are concerned. For example if we are calculating WMA for past 5 periods or price bars, when we move to the next bar, the oldest data point is dropped off and the most recent one is added. However, in case of EMA the old data points are never dropped off but their importance keeps on going down exponentially and hence the effect become negligible as we move ahead in time.

 

Data points for WMA

 

WMA replaces the old data points by the new ones.

 

Data Points for EMA

 

EMA does not replace old data points by new ones   

 

Differences between WMA and EMA on trading charts

 

Considering the fact that EMA has exponentially increasing importance for the most recent prices, you would think that EMA should stay closer to the price action than WMA. Well, looking at the above chart you would see that is not the case. Ask us why?

 

The reasons are two:

 

  • The way the exponent is calculated for an EMA. If the exponent calculation formula is changed to give a higher value then the EMA will also be higher and will remain closer to the price-action.

 

  • The way linear reduction in the weights are considered for WMA. In case the linear reduction is less than 1 then the WMA would stay more far from the price action.

 

Please note that the objective to use EMA is not to bring the line of averages closer to the price action but to have an indicator which reacts and responds faster whenever, either there is a direction change in the price-action or the momentum of the ongoing trend changes. 

 

    

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