The vwap trading strategy (volume-weighted average price) and indicator is a helpful tool traders use to get in and out of a trade. This important indicator shows the equilibrium level of a stock’s trading price intraday and is a popular support and resistance indicator. Many traders use this indicator and candlesticks on their charts to trade successfully. They pay close attention to how far price action is from vwap.
Table of Contents
VWAP Trading Strategy Basics
The VWAP trading strategy (volume-weighted average price) is an important intraday indicator for managing entries and exits. It averages the closing prices of a security intraday and is used as a guide for support and resistance levels. They are putting it in plain English. It’s the average price of the stock throughout the entire trading day. It’s great for intraday trading on 5 min and 1 min charts.
So what is with all the hype about VWAP? You have probably heard it mentioned if you have been checking out any message boards on trading sessions in our trade rooms. Everyone who trades day seems to always talk about it, right? In today’s post, we’ll talk about the VWAP trading strategy and answer that pesky question of what it is vwap. Ultimately, you’ll understand why you should use it to be a more proficient trader.
This indicator is a popular tool traders use to help manage entries and exits. I often use it for day trading and will show our traders how the price reacts with it in real time.
Most traders use it for short-term trading, meaning you’ll rarely see people using it hourly and above time frame charts. However, before people BUY using a longer time frame chart, they often reference vwap on an intraday chart (like 1,5,15 minutes, for example). The longer-term retail traders anchor VWAP to a key level of support on longer time frame charts (like hourly or daily) and use this level as a key support for swing trading. Vwap trading is a highly efficient and simple method because there isn’t much to it, and it’s easy to learn this strategy.
Anchored VWAP on TrendSpider targets the highest volume time frames. In this example, $TSLA sells off hard below the weekly VWAP and is trying hard to respect the daily VWAP.
How Is It Used in Trading?
Traders use it as support and resistance in a short time frame. Personally, 5-minute and 1-minute charts help the most, especially when trading penny stocks. Finally, you use it to assess the direction or trend of the stock. On the technical side, VWAP is calculated by adding the dollar amount traded for every trade transaction (price multiplied by the number of shares traded) and dividing it by the total shares traded for the day. If you’re a member of our trade room, you will hear us reference VWAP often on the live streams.
Day traders commonly apply Volume Weighted Average Prices on the 1-minute and 5-minute charts. Those time frames are used when day trading because price action moves quickly. In addition, traders like volatility as it brings quick profits and lots of long or short opportunities.
If you are quickly getting in and out of stock, you need an indicator showing a trend in place to help you make trading decisions. That’s what fast trading indicators are all about. VWAP in stocks is no different.
Price Action
The VWAP indicator starts at the price a stock opens at and moves up or down based on the volume and price action throughout the day. So it’s more sensitive to the market’s movement at the opening, but as the day progresses, the VWAP slows down.
You will see it stabilize and thus find a good entry based on its movement. It slows down at the end of the day because it takes in so much data that price movement does not affect its movement at the end of the trading day.
Remembering this, you will find that the VWAP indicator is a helpful guide. And it feels good to know other traders are also looking at it, making it a self-fulfilling prophecy indicator.
Is (VWAP) Volume Weighted Average Price a Good Indicator?
VWAP, aka volume-weighted average price, can be a very useful indicator. It shows the stock’s equilibrium price intraday. Many traders pay attention to this level because it’s a good support and resistance level. In addition, it’s a good area to pay attention to for entries and exits.
Liquidity Is Always A Plus!
Most importantly, it identifies the liquidity of the market. The more liquid the market is, the more the price moves, and the more VWAP moves around.
The bottom line is VWAP is an indicator that traders are aware of if they are looking to take a large position in any given stock. It’s not a foolproof indicator by any means. Patterns and indicators are never foolproof, but keeping track of them is very important.
The VWAP indicator shows the stock’s equilibrium, and the stock will always come back if it moves too far away from it in either direction. It’s like a rubber band; it wants to snap back. So traders eyeball VWAP’s location and are prepared for the price to return to it inevitably. Ideally, you’re looking at the stock volume, candlesticks, and maybe some moving averages.
What Is a VWAP Trading Strategy Anyway?
The VWAP intraday strategy for trading tells a short-term trader whether or not a stock is bearish or bullish. If a stock touches VWAP and falls below it, this lets you know it’s in a bearish trend. This is when you’d short the stock. In addition, it can help provide intraday price targets for buying and selling. VWAP will then become resistant if the price falls below.
Shorting is when you borrow shares from your broker and sell them. Then, you return those shares to your broker, and your profit is the difference.
Without the VWAP indicator, shorting would be more difficult. Why? Because you benefit from this indicator as a show of critical support and resistance.
If a price trades below VWAP and then breaks and begins to trade above it, you would be in a bullish trend. If this happens, then you’d take a long position.
When you long a stock, you expect the price to rise after entry. So using overbought VWAP to exit is a good strategy if you’re scalping and looking for a signal to exit a long or a short.
The chart above reviews the 5-minute timeframe vs. the daily time frame. A unique feature of Trendspider. This allows us to watch the price react to the daily anchored VWAP and VWAP in the 5-minute time frame. Notice how we gapped above the daily VWAP and then back-tested the 5-minute VWAP a few times before breaking out a consolidation pattern.
Support and Resistance
Volume-weighted average price shows you both support and resistance. Support and resistance are important because they can differentiate between a win and a loss. There are many different ways to find support and resistance.
Candlesticks, moving averages, and the volume-weighted average price are all different ways you can find it, and they’re all equally important. They each show you the little nuances happening as a stock moves.
The VWAP trading strategy can help to quiet the fireworks that are the moving averages. When a stock moves quickly, and you want in, it can provide a stable entry. The volume-weighted average price is both support and resistance, depending on your trade direction.
Also, when you see a price hitting the volume-weighted average price and its support, you will want that support level to hold if you want to get in.
How Do I Setup My VWAP in ThinkorSwim?
Importance
When it breaks support at VWAP, the volume-weighted average price becomes the new resistance. Also, ensuring a support or resistance level holds will decide the stock’s trend.
Please pay close attention to it as it breaks the support level of the volume-weighted average price and trades under it for the rest of the trading day. Hence, it is in a bearish trend.
Just like the opposite is true for a bullish trend. You want to see a price break and stay above the volume-weighted average price. You will notice that price action and VWAP go hand and hand.
VWAP plot is accompanied by two bands serving as overbought and oversold levels. The Upper band (overbought level) is plotted a specified number of standard deviations above the VWAP, and the Lower band (oversold level) is plotted similarly below the VWAP. Standard deviations are based on the difference between the price and VWAP.
Conclusion
Above all, the VWAP trading strategy is an important tool when day trading. It’s quite easy to master. If you are in our trade room, you’ll constantly hear someone telling you to watch and see if the price breaks the volume-weighted average price (VWAP).
That is because it’s such an important indicator. Of course, there isn’t an exact science to predicting what a stock will do. But knowing and using the tools provided to you will help you make the most informed decision possible.
However, it doesn’t mean the stock will go how you want it to. You can minimize your risk when you trade smart and use your indicators!
1-minute chart showing the price of $SRNE back testing VWAP several times intraday.
