Finding the average price based on the closing value will not give you an accurate description of the health of an asset.
This is where the VWAP comes into play. In this article, we’ll cover what VWAP is, and how you can trade it the right way.
Personally, I use price action mostly for day-to-day trading. This article is to help you understand how to use VWAP more efficiently.
Volume-weighted average price (VWAP) is a widely used indicator calculated by dividing the average share price of a stock by the total volume of shares exchanged over a given time period.
This indicator assists traders and analysts in determining if an asset’s current price is comparatively overpriced or underpriced in comparison to the day’s average trading price.
Since the VWAP responds to price fluctuations based on volume over a given time, it can add more value than standard 10, 50, or 200 moving average indicators.
For example, if a portfolio manager needs to buy thousands of shares but also wants to pay less than the day’s average price, the VWAP is typically the price to beat.
The Importance of VWAP
Since it integrates both price and volume into its value, most analysts believe the VWAP is more reflective of the stock’s true average price. The VWAP estimate is independent of the stock’s closing price and has no direct impact on it.
Furthermore, since institutional traders use the VWAP as a reference for trading executions, the VWAP price level is regarded as highly influential in intraday price action.
Using the VWAP
Most experienced traders believe that the VWAP is influential and useful when trading in short-term timeframes.
Skilled and nonprofessional traders alike believe that enough institutional traders use the VWAP as a point of reference. Traders also conclude that recognizing this dynamic must be incorporated into a trading strategy.
As a result, you might employ VWAP as a filter. This filter will be founded on the belief that buyers are more likely to build support when the price is lower than the VWAP.
In comparison, you can prefer the opposite strategy. You’d think that buying a stock should only happen when the price is higher than the VWAP, and short-selling should only happen when the price is lower.
This filter will be focused on the assumption that market watchers would be unable to obtain the desired price and would be forced to drive the stock deeper into its daily trend.
Neither strategy seems to have a statistical advantage when applied to a large number of trades. As a result, VWAP approaches must be combined with other price action studies.
This will allow you to work with a more profitable filter based on how you believe the day’s market action will unfold.
VWAP trading setup and examples
VWAP is an intraday market index that can be used to help investors determine whether to enter positions actively or passively. Many traders use the VWAP to help them buy at relatively low prices and sell at relatively higher prices.
VWAP has two simple setups: pullbacks and breakouts.
By far the most common setup for day traders looking for the best price is the VWAP pullback. Remember that day traders only have a few minutes to a few hours to complete a trade.
1. VWAP Pullback
The first method is for more aggressive traders, and it entails monitoring market activity as it approaches the VWAP.
Wait for the VWAP to break, then analyze the tape activity on time and prices. You’ll need to recognize when the selling pressure is will and the tape is going nuts. The aim is to predict when the selling pressure will be relieved and then enter the trade.
In this case, we buy as the price returns to the VWAP. We wait for a signal candle that indicates buying interest before pulling the trigger. The stop is set below the VWAP or the previous swing low, whichever is lower. The benefit is that the stop would be small in this smaller timeframe. And use a targeted approach for exits. It is also possible to put a trailing stop.
2. VWAP Breakout
This trading setup is intended for those who are unfamiliar with the VWAP indicator.
You have to wait for an asset to test the VWAP to the downside. After that, you’ll want to wait for the asset to close above the VWAP.
Then, you’ll look for buy over the high of the candle that closed above the VWAP.
Consider another example.
Here we’ll use two EMAs along with VWAP.
When the two EMAs and VWAP lines crossover, you can look for long and short opportunities.
– As the price breaks the VWAP, look for it to also break a critical swing low, indicating an immediate turnaround backed by volume. With a stop below this high-volume candle.
– As you can see on the chart, you can take long and short positions, when there’s a high-volume candle, and the EMAs and the VWAP lines crossover each other.
Advantages of using VWAP
1) It assists traders in cutting through the noise generated by highs, lows, open, close, and other candle formations, and benchmarking the current price to the VWAP.
2) Traders can quickly determine if quantities are being picked up (or sold) at low or high rates. He/she may deduce these details with a single glance.
3) It enables traders to purchase or sell at the correct price (the VWAP) rather than entering a trade at current rates.
4) VWAP, in particular, assists major traders such as institutions in trading at the best possible price.
When used in conjunction with market action or another technical trading technique, the VWAP indicator can help to ease the decision-making process. VWAP approaches must be combined with other price action studies to trade effectively.