Introduction
Moving averages are one of the most commonly used technical indicators in trading. It is a popular tool for traders as it smoothens the price action and helps identify trends in the market. However, a simple moving average (SMA) has its limitations, especially in volatile markets. To overcome this, traders use an advanced version of moving average known as Variable Moving Average (VMA). In this article, we will discuss VMA, how it works, and its applications in trading.
What is a Variable Moving Average (VMA)?
A Variable Moving Average (VMA) is an advanced version of the simple moving average (SMA). As the name suggests, the VMA is variable and adapts to market volatility. In other words, it adjusts the number of periods used in the calculation based on the current market conditions. The VMA was developed by Tushar Chande, a famous technical analyst, and is also known as Chande’s Variable Moving Average.
How does VMA work?
The VMA uses the ATR (Average True Range) to determine the number of periods used in the calculation. The ATR is a measure of volatility and represents the average range of price movements. The VMA adjusts the number of periods used in the calculation based on the current ATR value. For example, when the ATR value is high, the VMA uses a higher number of periods in the calculation, which results in a smoother line. On the other hand, when the ATR value is low, the VMA uses a lower number of periods in the calculation, which results in a choppy line.
The formula for VMA is as follows:
VMA = (Price * Volume / Total Volume) * ATR * K
Where, Price = Current price Volume = Current volume Total Volume = Total volume over the look-back period ATR = Average True Range over the look-back period K = A constant between 0 and 1 that determines the weight of the ATR in the calculation.
The VMA is a more complex calculation compared to the simple moving average, but it provides a more accurate representation of the current market conditions.
Applications of VMA in Trading
- Trend Identification
The VMA is an excellent tool for identifying trends in the market. As mentioned earlier, the VMA adjusts to market volatility, which makes it an ideal indicator for identifying trend changes. When the VMA is sloping up, it indicates an uptrend, and when the VMA is sloping down, it indicates a downtrend. The VMA can also be used in combination with other technical indicators such as the Relative Strength Index (RSI) to confirm trend changes.
- Trade Entry and Exit Signals
The VMA can also be used to generate trade signals. When the price crosses above the VMA, it indicates a buy signal, and when the price crosses below the VMA, it indicates a sell signal. The VMA can also be used in conjunction with other technical indicators such as the Moving Average Convergence Divergence (MACD) to generate more reliable trade signals.
- Stop Loss Placement
The VMA can also be used to determine stop loss placement. When a trader enters a long position, they can place their stop loss below the VMA. Similarly, when a trader enters a short position, they can place their stop loss above the VMA. This strategy ensures that the trader is always trading with the trend and reduces the risk of getting stopped out in a volatile market.
Advantages of VMA
- Adapts to Market Volatility
The VMA adapts to market volatility, which makes it an ideal tool for trading in volatile markets. The VMA adjusts the number of periods used in the calculation based on the current ATR value, which results in a more accurate representation of the current market conditions.
- Provides Smoother Trends
The VMA provides smoother trends compared to the simple moving average. This is because the VMA adjusts the number of periods used in the calculation based on the current market conditions, which results in a smoother line. This makes it easier for traders to identify trends in the market.
- Generates Reliable Trade Signals
The VMA generates reliable trade signals. When the price crosses above the VMA, it indicates a buy signal, and when the price crosses below the VMA, it indicates a sell signal. This strategy ensures that traders are always trading with the trend and reduces the risk of getting stopped out in a volatile market.
Disadvantages of VMA
- Complex Calculation
The VMA is a more complex calculation compared to the simple moving average, which makes it difficult for novice traders to use. Traders need to have a good understanding of technical analysis to use the VMA effectively.
- Lagging Indicator
The VMA is a lagging indicator, which means it lags behind the price action. This makes it difficult for traders to enter and exit trades at the optimal time.
Conclusion
The Variable Moving Average (VMA) is an advanced version of the simple moving average (SMA). The VMA adjusts the number of periods used in the calculation based on the current market conditions, which makes it an ideal tool for trading in volatile markets. The VMA provides smoother trends compared to the simple moving average, generates reliable trade signals, and can be used to determine stop loss placement. However, the VMA is a more complex calculation compared to the simple moving average, and it is a lagging indicator. Traders need to have a good understanding of technical analysis to use the VMA effectively. Overall, the VMA is a valuable tool for traders who want to identify trends in the market and generate reliable trade signals.