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Volume Weighted Average Price (VWAP)
What is Wvap?
In the ever-evolving landscape of stock markets, traders are constantly on the lookout for tools and strategies that can provide them with an edge. One such tool that has gained widespread popularity among traders is the Volume Weighted Average Price (VWAP). In this blog post, we will delve into the intricacies of VWAP trading, covering everything from its calculation and significance to various strategies for its application in the markets.
The Volume Weighted Average Price (VWAP) is a trading benchmark used by traders to gauge the average price at which a security has traded throughout the day, based on both volume and price. Unlike a simple average price, VWAP takes into account the volume traded at each price level, giving more weight to prices with higher trading volumes.
It provides Footprints of larger players as this is volume based indicator and they trade the larger volumes
Price where maximum volume for the day has taken place. multiplying volumes at various prices with respective prices and dividing final number with total volume.
Volume is generally considered one of the drivers of momentum, that's the reason some technical analysts keep an close eye on volumes.
The VWAP indicator can be used by day traders to monitor intraday price movement and figure out the average price of large orders.
VWAP Secrets and various ways to use VWAP
Now we will discuss various methods we can use vwap whi
1. Forming intraday view based on VWAP:
a) Single Day VWAP
A quick glance at the chart immediately provides you a gauge of relative strength or weakness of the stock based on VWAP.
When we plot VWAP on current day chart, can use use it for forming short term view on chart:
· A stock trading over intraday VWAP may be bullish
· A stock trading below VWAP may be bearish
b) 2 day VWAP:
Two consecutive days VWAP can be used jointly for forming a view on index / stock.
· Price Above both day VWAP - bullish
· Price Below both day VWAP - bearish
If todays VWAP is lower then yesterdays VWAP - it also indicated today selling sellers are ready to sell at price lower then yesterday
c) VWAP slope
The slope of VWAP indicates the direction and strength of the trend.
An upward sloping VWAP suggests an upward trend, indicating that the average price at which the stock has traded throughout the day is increasing.
A downward sloping VWAP indicates a downward trend.
By analyzing the slope, traders can identify whether the stock is currently in an uptrend, downtrend, or moving sideways.
2. VWAP breakout trades
When the stock price moves above the VWAP from below, it might signal a breakout, suggesting it's a good time to buy the stock. Conversely, if the stock price drops below the VWAP, it could indicate a potential opportunity to sell short as it breaks down.
In the provided chart, the market opened with a gap up but faced some selling pressure initially. However, the overall sentiment remained bullish, and once it broke out above the VWAP, it surged by nearly 200 points. Therefore, using VWAP as an entry signal can offer low-risk entry points with the potential for high reward-to-risk trades.
3. VWAP As support / Resistance
A straightforward way to use VWAP is to see if it's above or below the current stock price. If it's above, it can act like a support, meaning the stock might keep going up. If it's below, it could act like a resistance, suggesting the stock might struggle to rise. The direction of the VWAP line shows the trend, kind of like a trend line.
In given chart, nifty after initial bearish move recovered till vwap line, then acted as resistance and price started falling again after testing VWAP line.
4. VWAP as Trailing Stop loss
While traditional methods of setting trailing stop-loss levels involve fixed price points or percentages, utilizing the Volume Weighted Average Price (VWAP) as a trailing stop-loss can offer a dynamic and potentially more effective approach. We can trail our stop loss with certain points above VWAP assuming view changes with cross of VWAP.
To initiate a trade, set an initial stop-loss level below VWAP for long positions and above VWAP for short positions.
When the price moves in the desired direction, adjust the stop-loss order to trail along with VWAP. For long positions, move the stop-loss order closer to VWAP as the price rises; for short positions, move it farther away from VWAP as the price declines.
5. Anchored VWAP:
Normal VWAP is plotted for single day and it do not consider data of previous days. Anchored volume weighted average price [AVWAP] is a plotted from previous meaningful benchmark price or day on a chart selected by traders. Anchoring VWAP to specific events, such as earnings releases or major news announcements, allows traders to assess price movements relative to these events, providing valuable context for decision-making.
For example if we plot anchored VWAP from major top .. it will give average price at which positional sellers have sold their positions. and they are comfortable holding their positions till price is below this anchored VWAP. And above this level they might start covering their positions.
Remember, the VWAP works best when combined with other indicators, especially momentum indicators. Generally, we form view on direction & momentum based on other indicators and then use VWAP indicator as for entry & Stop loss purposes.
On what instruments we can use it?
Apart from index charts and stock charts it can be used on Option Charts and Straddle/ Strangle charts also.
VWAP on Options charts
As a option seller we can also apply VWAP on option charts and ti will give you decipline to sell only if its below VWAP ..
and use VWAP + certain points as a stop loss.
thus VWAP retest or VWAP breakdown will give us entry with very small stop loss and better risk reward
VWAP on Straddles charts
VWAP also works good on straddle and strangle prices.
We can use vwap as entry signal for entry into selling straddle/strangle.
if straddle price is below VWAP means combined premium is below their weighted average selling price and sellers are comfortable selling here.
Once in profit we can trail our stop loss using vwap.
Disclaimer:
1. Objective of this blog is share knowledge on Indicator and not the strategy.
2. Before using for trading please understand character of indicator and precautions to be taken while using.
3. A great indicator is useless without proper discipline and even mediocre indicator can do the trick with strong discipline.
4. Observe 100s of historical charts using this indicator or in combination of other indicators and see how it works. Then try to form the rules for entry / exit and stop loss.
