How to use WMA in ETF rotation strategy? What period WMA is used for industry ETF switching?

Using WMA in ETF rotation can boost portfolio performance by switching between industry ETFs based on momentum; a 20-day period is commonly used for effective trend analysis.

Jun 01, 2025 at 07:07 am

The utilization of Weighted Moving Average (WMA) in an ETF rotation strategy can significantly enhance the performance of your investment portfolio by allowing you to switch between different industry ETFs based on their momentum and trends. WMA is a type of moving average that assigns greater importance to recent prices, making it more responsive to new information than a simple moving average. In this article, we will delve into the specifics of using WMA in ETF rotation strategies and discuss the appropriate period for industry ETF switching.

Understanding WMA and Its Role in ETF Rotation

Weighted Moving Average (WMA) calculates the average of a set of data points, giving more weight to the most recent data. This method is particularly useful in the context of ETF rotation strategies because it helps investors identify trends more quickly. In an ETF rotation strategy, the goal is to shift investments from underperforming ETFs to those showing stronger performance, based on the signals provided by the WMA.

To effectively use WMA in an ETF rotation strategy, you need to understand how to calculate and interpret it. The formula for WMA is:

[ \text{WMA} = \frac{\sum_{i=1}^{n} w_i \cdot Pi}{\sum{i=1}^{n} w_i} ]

Where ( P_i ) is the price at time ( i ), and ( w_i ) is the weight assigned to that price. The weights are typically assigned in a linear fashion, with the most recent price receiving the highest weight.

Setting Up the WMA for ETF Rotation

To set up a WMA for an ETF rotation strategy, you will need to decide on the period over which the WMA will be calculated. A common period used for WMA in ETF rotation strategies is 20 days. This period is short enough to capture recent trends but long enough to filter out some of the noise in daily price movements.

Here's how you can set up a 20-day WMA for an ETF:

• Select the ETF you want to analyze.
• Gather the closing prices for the past 20 trading days.
• Assign weights to each of the 20 days. The most recent day receives a weight of 20, the second most recent day a weight of 19, and so on, down to the 20th day, which receives a weight of 1.
• Calculate the WMA using the formula provided above.

Using WMA to Identify Buy and Sell Signals

Once you have calculated the WMA for your selected ETFs, you can use it to identify buy and sell signals. A common strategy is to buy an ETF when its price crosses above its WMA and sell when the price crosses below the WMA. This strategy capitalizes on the momentum of the ETF, as indicated by the WMA.

For example, if the price of an ETF is trending upwards and crosses above its 20-day WMA, this could be a signal to buy the ETF. Conversely, if the price of the ETF falls below its 20-day WMA, it might be a signal to sell or switch to another ETF that is showing stronger momentum.

Period for Industry ETF Switching

The period used for industry ETF switching in a WMA-based rotation strategy is typically 20 days. This period strikes a balance between responsiveness to market changes and the need to avoid excessive trading due to short-term fluctuations.

When considering industry ETF switching, you should:

• Monitor the WMA of multiple industry ETFs.
• Compare the WMA trends across different ETFs to identify which industries are showing the strongest momentum.
• Switch to the ETF with the strongest upward WMA trend when the current holding's WMA indicates a downturn.

Implementing the ETF Rotation Strategy

To implement an ETF rotation strategy using WMA, follow these steps:

• Select a basket of industry ETFs that you want to rotate among.
• Calculate the 20-day WMA for each ETF in your basket.
• Monitor the WMA trends daily or weekly, depending on your trading frequency.
• Switch to the ETF with the highest WMA when the current holding's WMA shows a bearish crossover.

For example, if you are currently invested in an ETF in the technology sector and its 20-day WMA shows a bearish crossover, you would switch to an ETF in the healthcare sector if its 20-day WMA is showing a bullish trend.

Practical Example of ETF Rotation Using WMA

Let's consider a practical example to illustrate how to use WMA in an ETF rotation strategy. Suppose you have a basket of three ETFs: Technology ETF (TECH), Healthcare ETF (HEAL), and Energy ETF (ENERGY). You calculate the 20-day WMA for each ETF and find the following:

• TECH: Current price is $100, 20-day WMA is $98
• HEAL: Current price is $80, 20-day WMA is $82
• ENERGY: Current price is $50, 20-day WMA is $48

In this scenario, TECH is showing a bullish trend as its price is above its 20-day WMA. You decide to invest in TECH. After a few weeks, the WMA trends change:

• TECH: Current price is $95, 20-day WMA is $97
• HEAL: Current price is $85, 20-day WMA is $83
• ENERGY: Current price is $52, 20-day WMA is $50

Now, TECH is showing a bearish trend as its price has fallen below its 20-day WMA. HEAL, on the other hand, is showing a bullish trend. You would then switch your investment from TECH to HEAL.

FAQs

Q: Can I use different periods for WMA in ETF rotation strategies?

A: Yes, while a 20-day WMA is commonly used, you can experiment with different periods such as 10 days or 50 days to see which works best for your specific strategy and risk tolerance. Shorter periods will make the WMA more sensitive to price changes, while longer periods will provide a smoother trend line.

Q: How often should I check the WMA for my ETFs?

A: The frequency of checking the WMA depends on your trading style. For active traders, daily monitoring might be necessary. For those with a more passive approach, weekly or even monthly checks could suffice. It's important to strike a balance between staying updated and avoiding overtrading.

Q: Is WMA the only indicator I should use for ETF rotation?

A: While WMA can be a powerful tool for identifying trends, it's often beneficial to use it in conjunction with other indicators such as the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD). Combining multiple indicators can provide a more robust signal for ETF rotation.

Q: Can I automate the ETF rotation strategy using WMA?

A: Yes, many trading platforms and software allow you to automate your ETF rotation strategy based on WMA signals. You can set up rules to buy or sell ETFs when certain conditions are met, such as a price crossing above or below the WMA. This can help you execute your strategy more efficiently and consistently.