VWAP Introduction
Are you an active trader that trades without using VWAP?
If so, you are missing out on a very powerful daytrading tool!
It can help eliminate the intraday noise on your charts.
Let’s take a deeper look at the ins and outs of VWAP so that you can implement it in your analysis.
What is VWAP?
Volume Weighted Average Price is the average price of all the transactions within a trading session.
It is based solely on price and volume data of the current session and is plotted directly on a price chart.
The calculation starts on market open and terminates at session close. As such, you can only plot VWAP on intraday timeframes or tick charts.
The formula looks like this: VWAP = Total $ amount transacted (# of Shares Bought x Share Price) / Total Volume for the day
It is calculated by adding up the dollar amount traded for every transaction in a session and then dividing that by the total number of shares traded during that time.
The general idea with VWAP is to assess current price in relation to this benchmark in order to determine entry and exit points.
Institutional Perspective
VWAP is commonly used as a trading benchmark by large institutions and mutual funds.
In addition to this, VWAP helps these institutions identify liquidity points where they can execute large orders without disrupting the market.
After accumulating a position, institutions will compare their fill price to end of day VWAP values.
Buy orders that are filled below VWAP are considered good fills as the position was executed below average price.
Alternatively, sell orders executed above VWAP are deemed good fills as they were sold above the average price.
It is also used by many algorithmic and high-frequency trading programs. These brokers offer VWAP guaranteed order fills to clients as a passive tool to accumulate positions at “perceived” bargain prices.
Now that you know how institutions use it, let’s take a look at how retail traders can benefit from it.
Why use VWAP in your Daytrading plan?
One of the reasons we love VWAP is its ability to eliminate the noise that occurs throughout the trading session.
Knowing the price at which a majority of the volume has traded makes it easier to gauge a good level to buy or sell.
In addition to this, VWAP helps us with identifying intraday trends, shifts in momentum, as well as entries and exits.
Let’s take a look at some examples of how we utilize it in our trading below:
Intraday Trend Filter
We like to use VWAP in our analysis to identify whether an asset is bullish or bearish on the session.
In the above example, VWAP is the purple line displayed on a 10 tick range bar chart.
While prices may experience volatile swings intraday, VWAP helps cuts the noise in the charts.
If the market is trading below VWAP during a session we can define the intraday trend as bearish. Alternatively, if the market is trading above VWAP, we are in a bullish trend on the session.
Case Study
If you take note of example #1 on the chart, you can see that after a bounce, the market trades back above VWAP. After several rotations above it, the market breaks back below it and pushes to new lows. At this point, we can identify current order flow as bearish. We can now look to qualify shorts on any rips into previous key zones
Dynamic Support and Resistance Level
When a security is trending, we like to use VWAP to identify potential levels of support or resistance in order to find actionable trades.
The reason for this is that VWAP is the equilibrium price. So when a market moves too far away from it, it will often return to it before continuing in the direction of the overall trend.
One thing to note is that VWAP is much more sensitive to price moves at the start of the day than at the end of the session. This is because it is based on cumulative values which get larger toward the end of the session. Meaning new data in the latter end of the session has less effect on VWAP.
Case Study
If you take a look at examples #2 and #3 in the above chart, you can see this concept in action!
Note how the market trades back into VWAP on both occurrences. In the first example, the crude market trades into new lows at $60.10 before retracing thirty-five cents higher into the VWAP. Since we are already bearish on the market, this is a good potential level to short. After several rotations fail to move the market higher, we qualify a short trade for a move back into previous lows. The market sells off over a dollar on this VWAP rejection into $59.26.
In the latter example, the market pushes off the lows at $59.26 and we look to VWAP for a potential counter-trend target. The market trades up into VWAP at $59.95 and fails to break again. Since the trend is still bearish, we can look to qualify a short trade here for another move lower. The market collapses back down into previous lows offering us good profit opportunity.
While the above examples are based on bearish price action, the inverse will hold true for spotting bullish trade opportunities.
Identify Momentum Shifts
VWAP also helps us identify potential shifts in momentum throughout the trading session.
If a security trades lower in the morning but catches a bid into the afternoon, new buyers may be entering the market.
We will often wait for a convincing breakout over VWAP to confirm these buyers. It’s all about context with this type of trade.
What makes this play more probable is if there have been multiple failed attempts at VWAP earlier in the session. A breakout above VWAP after this type of context often indicates a short-term shift in momentum.
In this scenario, we look to qualify longs on a retest of VWAP as support for a move higher. This is actually one of our favorite setups to trade!
Case Study
If you take a look at example #4 in the above chart, you will see this scenario play out!
The market trades below VWAP until it catches a bid and retests it for the third time around 10:15 am. This time, however, the market is finally able to break above VWAP indicating a potential shift to bullish momentum. After the breakout, the market retraces back into VWAP, finds support and rips fifty cents higher.
In example #5 we see another example of a momentum shift involving VWAP, this time not as clean.
After some time above it, the crude market sells off into VWAP at $59.99 and breaks below it. Many momentum traders will short this breakdown for a continuation move lower. This price action forms a lower low on the range chart which is a bearish technical signal. Based on this, should price trade back into VWAP, we should see the sellers step in to hammer prices lower.
Take note what happens when the market actually trades back into VWAP! Initially, sellers step in and price reaches down into the $59.85 level. This selling is quickly absorbed and the market rotates back up above VWAP. There is a tug of war happening here between buyers and sellers. Based on market structure and price action, the sellers should be stepping in to push the market to new lows. However, every test of the $59.85 level seems to be getting absorbed by buyers until we finally get a breakout above VWAP and $60.10 on high volume. This signals a potential momentum shift to the bull side and we can now look to qualify long trades on dips into VWAP.
The Bottom Line
VWAP is a major level of importance that many big traders and institutions monitor.
Which is why you should be paying attention to it too!
We’ve given you the guide to utilizing it in your analysis. Now its time to plot it on your charts and study how price behaves around it throughout the session.
No doubt, you’ll start seeing the market in a new light!
We take advantage of VWAP setups every day in our live trading room with professional traders.
If you want to join us in our live trading room, check out the Pro Trader package here >
Want to trade more passively, checkout our newsletter, trade ideas and live analysis in the Swing Trader package here >
The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.
