Among others, the VWAP strategy is one of the most promising trading techniques. It considers time, volume, and price. These elements can result in more profitable trades if you know how to use them right.
Time is the most subjective among the factors influencing VWAP. For instance, it can be a few seconds for scalp traders and a few hours for day traders.
Price, on the other hand, shows who controls the market. It could be the buyers, sellers, or both. When the latter happens, there’s an equilibrium in the trading market.
VWAP is especially valuable among buy-and-hold traders. It lets them know if the price they traded is good or bad.
In this article, I’ll talk about VWAP meaning and some strategies to optimize its benefits. Keep on reading to learn more about the VWAP trading strategy.
What Is Volume-Weighted Average Price (VWAP)?
VWAP is a trading indicator that looks at an asset’s average price within a specific period and calculates its weighted volume. It’s a lagging indicator. Further, it’s a popular strategy among short-term and day traders.
In the simplest terms, VWAP is the cumulative average price with respect to volume.
Some users of VWAP include market makers, institutional traders, and retail traders. It’s popular because of its many benefits, including the following:
- A simple tool that beginners can easily understand
- Easily gauges if the stock is cheap[ or expensive in a day
- Helps identify the right entry and exit times
- Determine trend changes
- Shows who’s in control of the market
- Acts as a support and resistance
Further, investors use VWAP as a benchmark. It’s popular among passive investors. With VWAP, you can determine if an asset has a good buying or selling price.
When VWAP rises, the buyers control the market. On the other hand, sellers have control of the market if VWAP falls. When it’s flat, no one has control. Consequently, it indicates a trading range.
By combining price and volume in a single indicator, analysts believe VWAP can provide a good representation of a stock’s performance.
VWAP starts daily, offering a fresh take on trading. Because volume tends to be heaviest during the start of the market, it’s given more emphasis in VWAP computation.
A good understanding of a VWAP indicator helps traders spot market trends. The line resets daily, which makes it a useful tool for day traders.
How Is Volume-Weighted Average Price (VWAP) Calculated?
Calculating VWAP is one thing you must learn to take advantage of this trading strategy. Here’s a simple formula:
VWAP = Cumulative Typical Price x Volume / Cumulative Volume
Typical Price = High Price + Low Price + Closing Price / 3
As you can see, the typical price is the average of the prices within the trading day. On the other hand, the cumulative price is the total price since the opening during the trading day.
Note that the computation is independent of the closing price of the stock. It also does not have a direct impact on the latter.
You don’t need to manually compute VWAP. Instead, charting software can come in handy. Even better, it can provide visual representations. In turn, it is easier to understand the market movements.
Traders utilize various indicators when using VWAP. Among others, support/resistance can be beneficial. They show price levels that can signify a pause or reversal of a current market trend.
Support happens when traders expect the downtrend to halt because of demand concentration. On the other hand, resistance is when people anticipate an uptrend to pause because of supply concentration.
It’s crucial to know how to interpret the VWAP line. The direction demonstrates the trend. Trading above the line means the asset acts as a support. On the other hand, trading below it means the stock acts as a resistance.
Entry and Exit Levels
Knowing when to enter and exit the market can make your trades more profitable. Timing is crucial. If you’re too early or too late, you can miss big opportunities and suffer from significant losses.
With proper interpretation, VWAP strategy orries as long as she has everything done before she goeshelps traders identify a good entry point. It depends on the relative value of previous trades. Consequently, it can identify the best exit time. It’s when an asset’s price action is going too far too fast. Such signals can lessen the risks.
Some, however, may act on impulse. A good way to avoid such is to use multiple indicators aside from entry and exit levels. This way, you can confirm market movements and have a more solid basis for your next move.
Gauge Relative Strength
In the stock market, relative strength is an important momentum indicator. It helps traders choose an asset depending on how it outperforms predictions or the performance of other assets. The assumption is that the asset will continue outperforming its counterparts.
Looking at the VWAP chart provides an immediate analysis of the stock’s relative strength or weakness. In turn, it helps you analyze your next trading strategy. Without such, your trading is a guessing game without a solid basis.
While VWAP is a good tool for gauging relative strength, it’s best to use such with other indicators. It will help in trend confirmation.
Trade VWAP Price Crosses
A breakout happens when the price of an underlying stock crosses the VWAP. It could be a sign to go long. Meanwhile, when the stock goes below the VWAP, it can indicate a short-sell, which happens upon breaking down.
The cross is a trading indicator you’ll see when the VWAP crosses the price . Volume and price are two crucial factors that influence this trend.
In addition, the VWAP price cross can indicate a stop area when support breaks. Hence, you’ll have a more strategic plan to optimize profits. As mentioned, you must complement it with other indicators for best outcomes. Among others, one that can be useful is momentum indicator.