Moving averages are a cornerstone of technical analysis, helping to smooth out short-term price fluctuations and highlight longer-term trends. While the simple moving average (SMA) and exponential moving average (EMA) take only price data into account, a volume-weighted moving average (VWMA) also incorporates volume data, revealing another important aspect of technical analysis.
The VWMA averages price data with an emphasis on volume, meaning areas with higher volume will have a greater weight. On heavy volume days, the VWMA will more closely follow price, and on lower volume days the VWMA will act similarly to a simple moving average.
How is VWMA Used?
Often used in combination with other indicators, a volume-weighted moving average can help traders:
- Discover emerging trends – When increased volume accompanies buying or selling pressure, the VWMA should more closely follow the closing price of each bar, crossing above or below an SMA of the same period.
- Confirm existing trends – If the VWMA is located between price bars and the SMA, this can help traders judge the strength of a trend. The more divergence between the VWMA and the SMA, the stronger the trend.
- Identify Market reversals – Similar to discovering emerging trends, the opposite signal can be used to help traders mark the end of a market trend.
Example of VWMA Analysis
In the example below, a volume-weighted moving average is used in combination with a shorter-period simple moving average on a 5-minute Micro E-mini S&P 500 futures chart. A volume indicator is in the lower panel displayed with white bars. When the faster 15-period VWMA (blue line) crossed above the longer 20-period SMA (yellow line), price continued to rise from a choppy channel, indicating a potential emerging uptrend.
Additionally, after a volume spike the VWMA diverged further away from the SMA and closer to the price bars, revealing a potential increase in trend strength.
All indicators can produce false signals and traders should always be aware of the financial risks involved when trading live markets.
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