WEIGHTED MOVING AVERAGES

Most binary options traders, like traders of other instruments, use moving averages on their charts. While simple moving averages are popular, they do have limitations. A simple moving average is a severely lagging indicator because it is calculated from a period of past prices that are all weighted equally. Some simple moving averages barely react to large changes in current price. This has led many technicians to believe that simple moving averages to do not adequately reflect the ever changing influences on a market’s current price. As a result, many traders prefer to use weighted moving averages, which give more mathematical significance to the most recent price periods used in their calculation. Moving averages can be weighted linearly or exponentially.

Linearly weighted moving averages distribute the weight for each number in the calculation with linearly decreasing significance extending into the past. For instance, a 10-period linearly weighted moving average might multiply the most recent closing price by 10 and the second most recent by 9 before adding them together, then add THAT to the third most recent multiplied by 8, and so on. The sum will be divided by 55, which is 10+9+8+7+6…etc. The result is that the most recent price action most heavily influences the newest point on the moving average line.

Exponentially weighted moving averages assign even more weight to the most recent period’s closing price. Each new closing price is typically given 10% of the total numeric weighting in the average, with all of the rest of the points combined receiving the remaining 90%. The second most recent will be assigned 10% of that remaining 90%, and this trend continues as the periods go farther back in time. The result can be that the period farthest in the past has an almost completely insignificant influence on the calculation.

Generally, weighted moving averages create smooth, trend-identifying lines just like simple moving averages. The difference is that weighted moving averages—even long term ones—will be more sensitive to large changes in current price so that they more accurately reflect the constantly changing dynamics of a market in real time.