The volume-weighted average price (VWAP) is a simple and effective trading indicator. Most traders use the VWAP trading strategies as part of their trade entry and exits.
This indicator is very important because it displays the level at which a stock's trading price reaches equilibrium within a trading day, it is also commonly used as a support and resistance indicator.
When combined with the candlesticks on your chart, this indicator will make you trade successfully.
What is VWAP (volume weighted average price)?
The volume-weighted average price (VWAP), as the name implies, is the average stock price adjusted for the volume of trades. VWAP, a widely used benchmark, is created by dividing the average share price of a stock by the total volume of shares traded within a particular time frame.
It lets investors compare the current stock price to a benchmark and determine when to enter and exit the market by calculating the average price of a stock over a time frame.
In other words, it aids analysts and investors in assessing a stock's current price to determine whether it is generally overpriced or underpriced in comparison to the day's average trading price. The VWAP can help investors choose whether to take an active or passive strategy for a company, enabling them to execute the ideal move at the ideal moment and hit their profit target.
VWAP serves as a benchmark for institutional investors that frequently trade in large orders to assess the quality of executions.
For instance, if a fund manager wanted to buy 20,000 shares of firm X at a price lower than the day's average price, he would monitor the VWAP and aim to beat it because that will be the criterion for determining if he was successful in getting in at a good price. The VWAP at the time the position was accumulated would be contrasted with their average buying price.
What is the VWAP Trading Strategies?
Volume Weighted Average Price trading strategy is one of the most important intraday trading strategies to have. Most short-term traders and algorithm-based trading platforms use these tools. The majority of ordinary traders are not very concerned about the market price fluctuating each time they make a trade, but large institutional investors and market makers may be significantly concerned.
Consider a hedge fund that wants to unload a stock in which it holds a position that represents a sizeable portion of the company's overall market capitalization. Every time they try to sell, they face the danger of driving the price down, which is obviously not what they would want, if daily trading volumes in that market are insufficient.
This means that orders must be “worked,” with the position being sold in increments over a period of time that avoids self-defeating price movements.
The same rules hold true for funds trying to build bigger positions, the volume-weighted average price indicator is a criterion these major investors employ to make sure they aren't saturating the market. When buying, people prefer to pay less than VWAP, and when selling, the opposite is true.
However, a portfolio manager at a large fund will stick to their role as the “ideas guy” by having a trader on their desk or by using the firm's dedicated trading desk, in order to execute their orders. Hedge funds don’t usually disclose specifics on the structures of their trading floors.
The VWAP trading strategy is a metric used to determine how successful a trader or trading desk is at obtaining the best price, which is their exclusive goal. At the market opening and market closing, their trading day begins. Even if there are orders still outstanding for the following day, they are day traders aiming to maximize trading earnings by buying and selling highs and lows in intraday trading.
Why is VWAP So Important?
Based on how it is applied, the volume-weighted average indicator is important. Depending on the position the stock is being traded, as it relates to the line of the VWAP, it gives you an idea of the price action and momentum.
When a stock trades right above the VWAP when the line rises, that is an uptrend, a downtrend is indicated by the opposite. Additionally, because the VWAP is used by institutional traders to execute, the price level of the VWAP has been deemed a big influence on price action in intraday trading.
An example is: if stock A has a dropping VWAP line, you would wish to play along with the trend by waiting for the price of the stock to break through the VWAP line and begin an uptrend. Because of its relationship to the trend's direction and stock price, VWAP offers a visual representation of demand and supply.
What is the VWAP Indicator?
Volume Weighted Average Price referred to as VWAP, is a vwap strategy used by investors. The VWAP indicator is one of many technical analysis instruments that can be used to assess the performance of a security. It provides the average price the asset has traded at throughout the course of a day, to be more precise.
Many traders use the VWAP strategy/Indicator to assess a stock's performance in relation to a benchmark value, which should provide them with sufficient knowledge to enable them to decide whether to purchase or sell it.
The market's liquidity is what it identifies most crucially. Price and VWAP both swing more and more when market liquidity increases.
In conclusion, day traders should be aware of VWAP strategies if they want to take a sizable stake in a certain company. By no means is it a foolproof predictor. Although patterns and indicators are never 100% accurate, it's crucial to keep watch on this one.
A stock will always return to its equilibrium, as shown by the VWAP indicator if it deviates too far from it in either direction. It wants to snap back like a rubber band. So, intraday traders can scan the area around VWAP and be ready for the price to inevitably return there.
In a perfect world, you would be examining the stock volume, candlesticks, and possibly some moving averages. Want to learn how to trade stocks? To assist you in getting started, be sure to check out some of our articles on this website
How to use VWAP indicator
The ability to view trading activity throughout day trading makes the VWAP indicator a handy tool for traders. If they purchased the asset below the VWAP line at the end of trading, they did so at a favorable price. They might have overpaid if they purchased it when it was above the VWAP.
Every day, the VWAP indicator is calculated. The data that makes up begins when trading opens and concludes when the trade closes.
The VWAP can be traded in a variety of ways. Once more, it functions best in conjunction with additional complementing indicators, such as momentum indicators like stochastic or MACD.
To Gauge Relative Strength
When a stock trades above its intraday VWAP, it may be bullish; when it trades below, it may be negative. You can quickly determine the relative strength or weakness of the position by taking a fast look at the chart. You may evaluate whether your stock is showing relative strength or weakness by comparing the VWAP reading for benchmark indices and peer companies.
Additionally, it helps you consider your trade more carefully. For instance, short selling an uptrending stock that is trading over its VWAP puts it at risk for a short squeeze because you are going against the trend. The relative weakness that is in line with the trend can be traded by short-selling a stock that is in a downtrend and trading below the VWAP.
Support/Resistance
The VWAP can also be easily used to gauge support and resistance levels. You will easily notice the VWAP line acting like support when the stock trades above it while it acts like resistance when the stock trades below the line. The VWAP line basically serves as a trend line because its direction indicates the trend.
To Display Levels of Exit and Entry
Resistance for one trader is support for another. This means that, if you’re going short on a stock, you can exit at that price point, if the stock is trading below the VWAP. However, if you’re going long, you should wait till the stock either breaks through the VWAP or reverses and bounces off.
The VWAP is an excellent area to enter and exit trades. You can use these for entries toward the VWAP if you have the associated higher and lower envelopes.
Trading Price Crossing the VWAP
A breakout may occur when the price of a stock crosses the VWAP upward from below. This may indicate that it is time to take a long position on a stock. A stock falling below the VWAP line can give off signals of a short-sell trade when breaking downward. If you don’t have support, the VWAP also functions well as a stopping point.
For instance, you might want to enter a trade on the VWAP line at $27.10 and set a trailing stop at $0.19 under the VWAP line. At this point, you can create a good vwap trading strategy. Keep in mind that the VWAP performs best when used in conjunction with other indicators, particularly momentum indicators.
How to Read VWAP
The use case for VWAP is fundamentally identical to the use case for a simple moving average. When prices climb above the VWAP, it can mean that the security is starting to trend upward or has already started doing so; conversely, when they fall below it, it might mean that a downtrend is about to start or is currently happening in day trading.
Some traders in day trading believe that an increase in volume is required to confirm a new trend since they perceive the price as an insufficient trend indicator on its own. These traders in particular have the propensity to employ VWAP to establish the guidelines for their trend-based trading methods.
The indicator itself is quite straightforward. On a chart, it is shown as a line, and when the price crosses it, it indicates that the stock is likely in an uptrend; when it crosses it, it indicates that the stock is likely in a downtrend.
Chart 1 of the VWAP
A smooth blue line can be seen adjacent to the angular green pricing line if you look attentively. The VWAP is shown by this straight line.
Since they occasionally don't line up, we can see that trend patterns are developing at certain times. As an illustration, the VWAP indicator is rather accurate in this case. This demonstrates how, potentially, the VWAP indicator might assist in generating safe returns.
VWAP chart 2
This chart shows the stock is initially in a strong upward trend but shifts to a downward trend with time.
VWAP Formula and VWAP Calculation
Formula
VWAP is essentially a mathematical formula. VWAP is defined as the average price of an asset’s ratio to the trade volume the asset has amassed during a specific time period in the highest-level summary description.
The VWAP is determined (automatically) by averaging the high, low, and close prices for the specified time period, and then dividing that result by the total number of transactions for the specified time period.
To derive the VWAP throughout the day, you would need to keep updating the formula for each time period as the day went on. Since this might be time-consuming, the majority of trading platforms will continuously calculate the VWAP as an indicator.
Calculation
The starting intraday price is used to calculate the VWAP, which is then adjusted up to the session's end. Thus, only intraday data are used in the calculation. The following equation can be used to determine VWAP:
VWAP is equal to the product of cumulative volume and cumulative average price.
The computation is dependent on the time frame being used to see the price chart because it starts with the typical price of the first finished candle or bar on your chart. An illustration is: if you open a 5-minute chart, it is likely the TP of the candle or bar within the first 5 minutes. The true average price of the candle's closing price, high price, and low price determines the price level.
The Total Price Volume is obtained by multiplying the Typical Price by volume during the measurement period as the following step in the VWAP computation (TPV).
Because the volume component cancels out in the initial computation, the first candle’s VWAP will likely be the typical price. For the following candle, things differ. The formula is used to calculate the second candle’s following procedure and each candle after that to determine the cumulative volume and price:
Candle 1 + Candle 2 = [V (Candle 1) + V (Candle 2)] / [TPV (Candle 1) + TPV (Candle 2)]
The second candle’s price and volume product would be 1,406,720 if we assume that it closed at 43.96, which is the usual price, and at a 32000 volume. This sum would be included in the first candle's TPV. To provide the current VWAP in real-time, the VWAP retains a running sum of the price data and volume that have been gathered during the day.
To further the example, subtracting the TPV total from the CV of 67,000 (which is the addition of the value of candles 1 and 2) will provide the VWAP.
The indicator determines the VWAP for each data point in a stock chart within a trading day for any time period. Algorithms on the charting platform carry out this automatically. To examine the VWAP computation results, you merely need to pick an intraday time window.
What does the VWAP report?
Analysts believe the VWAP to be a more accurate measure of the underlying average price of the stock than the moving average because it incorporates both price and trading volume into its calculation. Furthermore, the stock's closing price has no bearing on or influence on how the VWAP is determined.
Depending on how you wish to use the VWAP indicator, it might tell you a lot about the pricing.
It first provides context for the price trend and market momentum relative to where the stock is trading in relation to the VWAP line, above or below. The stock is most likely in an uptrend with bullish momentum if it is trading above the VWAP as the line rises. The stock is most likely in a decline with bearish momentum if it is trading below the VWAP line while the line descends, on the other hand.
Additionally, the VWAP price level is thought to have a significant impact on intraday price action since institutional traders utilize it as a benchmark for execution activity.
For instance, if Apple's VWAP line is falling and you want to buy shares, you might want to hold off until the stock price breaks through the VWAP and turns around, indicating that the short-term momentum is no longer bearish before you place your trade.
However, because the VWAP is derived from previous data, it is still regarded as a lagging indicator. However, most traders continue to use the indicator to determine support and resistance levels appropriate for intraday trading. Based on its relationship to the stock price and the trend's direction, it offers a visual representation of supply and demand.
Additionally, as many day traders utilize the VWAP, it frequently exhibits the traits of a self-fulfilling prophecy.
For instance, retail traders may predict that stock would climb to test the VWAP if it is trading higher but is still below it. As a result, they place purchase orders that are aimed toward the VWAP level. The stock may increase naturally toward the VWAP as additional traders join in an effort to be ahead of the pack.
Furthering the point, short sellers who anticipate rejection at the VWAP level may place limit sell orders to short-sell the stock at the VWAP in anticipation of profit-seekers and additional selling entering the market and bringing the price down. Regardless of how you choose to read it, the VWAP is most helpful when used in conjunction with other indicators to support the longer-term market trend.
What is the Best VWAP Settings?
The sideways markets with lots of false signals and noise are best suited for the VWAP. In such markets, traders must distinguish between signal and noise in order to more accurately predict the direction and size of future returns.
Traders may be able to recognize a directional change when the price crosses the VWAP level by comparing the price movement and the VWAP. According to their personal trading preferences and the anticipated direction of the price, they may take either long positions or short bets.
Conclusion
The vwap trading strategy provides good trading opportunities. It's conceivable to characterize sideways trading, or range-bound, trading day as one in which price frequently trades above and below VWAP because several definitions of market terminologies are ambiguous in nature.
A day with price action over VWAP would be seen to have bullish momentum, whereas one with price movement below VWAP would have bearish momentum. As much as it can be used to pinpoint trading entry and exit points, VWAP can also be utilized to better comprehend the market.
The fact that VWAP is a lagging indicator prevents it from being a trading tip. Additionally, it is not appropriate for trading the first few bars of a trading session and is only marginally useful for investors with medium- to long-term time horizons
But it does raise the bar for comprehension and give a window into what major funds might be doing in the market. A large number of day traders also successfully navigate the intraday markets using VWAP.