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VWAP is a term traders and chartists are likely to have heard. In this case, we are looking at the volume weight average price VWAP indicator, which is a moving average indicator. Many traders use this useful indicator together, such as retail traders, institutional traders, and market makers.
The following material is suitable for people who love trading indicators. Today, our goal is to introduce you to an indicator that considers both volume and price. Here is the powerful Volume Weighted Average Price (VWAP) indicator detail!
What is Volume-Weighted average price (VWAP)?
VWAP is a gauge of short-term price trends used on intraday charts (time frames that occur throughout the day, such as 1 minute, 5 minutes, 1 hour, etc.). It shows the average stock price weighted by daily trading volume as a single line.
Retail and professional traders can use the VWAP to identify liquidity points or confirm trends with this indicator as part of their trading strategies. In addition, this indicator can see the target price in a particular market.
Volume-Weighted average price formula
To calculate VWAP, you add up the dollars traded for every trade (price multiplied by several shares) and divide it by the total shares traded.
VWAP= ∑Price * Volume/∑Volume
How to calculate the Volume-Weighted average price?
VWAP completes all calculations for you when added to a chart. Here are the steps for calculating VWAP yourself. The calculation remains the same regardless of the intraday time frame, such as a 5-minute chart.
During the first 5-minute period of the day, find the stock’s average price. Next, the high, low, and close are added together and divided by three. The volume is then multiplied by this number. Record this information in a spreadsheet under the PV column.
PV should be divided by volume. The VWAP value will be the result.
To keep the VWAP value constant throughout the day:
- Add the PV values from each period to the previous values.
- Divide the total by the volume for the day.
- Make a spreadsheet with a column for cumulative PV and a column for cumulative volume. The ratio between these two values will give you VWAP.
What does VWAP tell you?
VWAP ratios are used by institutions and mutual funds to help them move into or out of stocks with the least possible impact on the market. So when the VWAP is below or above, institutions will try to buy or sell below it. So they push the price back towards the average instead of pushing it away from it.
VWAP may be used by traders for trend confirmation and as the basis for building trading rules. A long position might be initiated, for example, when the price exceeds VWAP. However, they may choose to initiate short positions when the price falls below VWAP.
Why is VWAP important?
VWAP is a significant indicator of its application. Depending on where the stock price is trading (above or below), the VWAP line provides context for the price trend. For example, a stock is above the VWAP uptrend line in an uptrend, and the reverse is valid for a stock below the VWAP downtrend line.
If, for example, XYZ had a falling VWAP line, you might want to play with the trend until the stock price pierced the VWAP line and reversed back up. This is because, in VWAP, supply and demand are related to stock prices and trend direction.
How to trade with VWAP?
With the VWAP, you can trade in many ways. However, it is most effective when used with other complementary indicators, including momentum indicators such as MACD or stochastics.
VWAP is one of the easiest ways to gauge support and resistance. The VWAP line is used as a support and resistance line based on whether the stock is trading above or below. In addition, by using the VWAP line as a trend line, we can determine the direction of the trend.
Entry and exit levels
Another trader’s support might be another trader’s resistance. VWAP can be an exit target for long stock traders if the price falls below. Long positions can be taken by traders waiting for the stock to break out through the VWAP or pullbacks and bounces off the VWAP.
Traders can take advantage of this area to enter and exit positions. You can also use the accompanying higher and lower envelopes to enter data back towards the VWAP if you possess them.
Gauge relative strength
In general, the price of stock above VWAP may be bullish, while the price of a stock below VWAP may be bearish. The chart gives you an immediate sense of relative strength or weakness. When the VWAP readings for benchmark indexes and peer stocks are combined, you can compare and gauge your stock’s relative strength and weakness.
It also provides a more in-depth view of your trade. For example, buying short a stock that is trending higher and trading above its VWAP makes it susceptible to a short squeeze since it is trading in the opposite direction of the trend. Conversely, shorting a down-trending stock and trading below the VWAP can allow you to trade relative weakness aligned with the trend.
Trade VWAP price crosses
The underlying stock price crosses the VWAP up from below, representing a breakout. The signal could indicate buying the stock. Stocks below the VWAP are more likely to break down and signal a short-sell trade. The VWAP also provides a good stop area in case of broken support.
You may, for example, plan on entering XYZ on a breakout through $27.10, which is the VWAP, and placing a trail stop $0.20 below the VWAP. With this, you can develop a quantifiable game plan for your business. Remember, the VWAP works best when combined with complementarity indicators, particularly momentum indicators.
How do you read a VWAP chart?
In common with most technical indicators, the VWAP can be interpreted in various ways. For example, VWAP can also be used to establish support and resistance, signal an overextended trend, or as part of a combination with another indicator.
1. Support and Resistance
One of the most objective and simplest ways to read a chart is to use VWAP. Using a VWAP chart as an indicator for the short-term support or resistance level is one way to read it. Further weakness could follow if prices break below support. Conversely, it could indicate more bullish momentum is still ahead if prices break above resistance.
The most common way to measure support and resistance is by using historical price points, but short time frames make this more difficult. So instead, short-term movements can be predicted using volume-weighted indicators like the VWAP.
2. Trend Overextended
A short-term VWAP indicator may show price action times far exceed the VWAP line.
When a security’s price rises quickly above its line on heavy volume, it may indicate that it is overbought, and traders might decide to short it. Price rapidly falling below the line can indicate that security has become oversold, and traders might take a long position.
As with all subjective matters, defining “overextended” is not as straightforward as it seems. Assuming that prices tend to return to or close to the VWAP line, investors assume that when prices exceed this line in one direction, they might eventually snap back to the VWAP.
3. VWAP Plus MACD
Like many other technical indicators, the VWAP indicator is often combined with other variables. However, using multiple indicators can improve the effectiveness of technical analysis. For example, investors can feel more confident about their projections when they confirm trends in multiple ways.
A trader might consider looking at the VWAP paired with the Moving Average Convergence Divergence (MACD).
MACD crossovers on the MACD lines just before the VWAP line becomes overextended to the downside could indicate a potential buying opportunity. Conversely, as long as prices stretch far above the VWAP line, a bearish crossover on the MACD could indicate a good time to close out trades or establish short positions.
Is VWAP good for swing trading?
The question, “What does VWAP in trading mean?” is impossible to answer, wildly swing trading is being discussed.
VWAPs tend to work well for short-term trading, including day trading and short- to medium-term trading, such as swing trading, in which investors hold a position from a few days up to a few weeks.
The VWAP might be a valuable tool for swing traders when determining whether to keep their positions open every day. An investor can determine when to sell based on whether a short-term chart consistently shows prices below VWAP and other factors.
How do investors calculate 30-Day VWAP?
An average of daily VWAPs for 30 days is the 30-day VWAP. The 30-day VWAP is calculated by adding the closing VWAP every 30 days and dividing the sum by 30.
A cumulative indicator
In VWAP, the number of data points rises steadily throughout the day, so it’s essential to keep this in mind. In a given chart, every measurement of time is represented by a data point, and as days pass, these points accumulate.
Within an hour of the market opening, a 5-minute chart would feature 12 data points, 36 after three hours, and 84 at the market close. VWAP lags the price in this manner, and the lag gets longer as time goes on.
Limitations of using the Volume-Weighted average price
VWAP is a one-day indicator reset at the beginning of every new trading day. Using an average VWAP over many days may distort the VWAP reading from its actual value.
Some institutions may prefer to buy securities below VWAP or sell them above VWAP, but VWAP is not necessarily the only factor to consider. For example, in a strong uptrend, the price may move higher for many days without ever or only occasionally falling below the VWAP. Thus, if prices rise quickly and the VWAP falls below, you might lose out on an opportunity.
VWAP is a historical value-based model without any inherent predictive or calculation capabilities. The VWAP indicator increases its lag as the day goes on because the indicator is anchored to the opening price range. In particular, a VWAP calculation for 1-minute periods after 330 minutes (the length of a typical trading session) may resemble a 390-minute moving average at the end of the trading session.
Pros of VWAP
VWAP ratios assist investors and traders in determining the best price at which to buy or sell based on the volume of the market. Traders can expect lower transaction costs and better execution when they ensure high liquidity.
VWAP is especially helpful to investors who trade a large number of shares. By using VWAP, traders can ensure that they are not overinflating trading volume for the asset they want to purchase. For example, buying a large volume of a single stock on the market could artificially increase its price.
Cons of VWAP
Using the VWAP ratio raises a few issues. The problem is that VWAPs are cumulative indicators, which means they are based on a great deal of data which will only increase over time. As a result, large data sets often cause VWAP lags, much like moving averages lag, so most traders and investors only use five-minute and one-minute timeframes.
- What does the VWAP tell you?
A volume-weighted average price (VWAP) measures a security’s price as it has traded throughout a trading session, based on volume and price.
- Is VWAP only for day trading?
The VWAP is only calculated daily, whereas the MVWAP can vary over time because it is an average of an average. A moving average volume-weighted price is thus available to long-term traders.
- Is VWAP useful?
Trading and investment analysts use VWAP to eliminate the noise throughout the day to gauge what prices buyers and sellers are paying for stocks and markets. Based on their trading activities, traders can use VWAP to determine which stock is a good buy or sell at a given price.
The VWAP is a fantastic technical indicator because it considers both price AND volume. VWAP gives disproportionate weight to high volume price points rather than moving averages. As a result, you can identify prime entries/exits, gauge relative strength, and understand price points of interest.
Volatility-weighted average price provides insight into price action and volume related to a single day, which is helpful for intraday analysis. A trader might use this data point to develop an investment strategy.
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst