VWAP Indicator

What is VWAP?

The Volume-Weighted Average Price (VWAP) is a trading benchmark that reflects the average price a security has traded throughout the day, based on both volume and price. It is calculated by taking the total value traded (price multiplied by volume) and dividing it by the total volume traded. VWAP indicates the average price investors have paid for a security, helping traders assess the efficiency of their trade executions. It is commonly used by traders to gauge market trends and to make informed trading decisions. 
 

How is VWAP Calculated? 

The computation begins with the market's opening bell and concludes with the closing bell. As the VWAP is an intraday indicator, it is calculated using intraday data. Today, owing to technological improvements, you can quickly add any popular technical indicator, such as VWAP, to a price chart with a few clicks. The next section will discuss how to compute VWAP manually in depth.

The mathematical method for calculating the volume-weighted average price is:  

VWAP = Typical Price*Volume/Cumulative Volume

Why Is VWAP used?

VWAP is used differently by different sorts of traders. For example, they may use it to corroborate trends. A trader who uses VWAP as a trend confirmation tool may use it to initiate trading positions. So, if the price falls below the VWAP and rises above it, the trader may enter long bets. 

On the other hand, if the price above VWAP drops below it, the trader may go short. Institutions such as insurance firms, mutual funds, and hedge funds may utilize the VWAP to conduct transactions with little market effect.

Importance of Volume Weighted Average Price

VWAP provides information on the stock's actual average price. This share is similar to the moving average, which is based on past data and facilitates decision-making in intraday trading. Among investors, VWAP is an often-used instrument. The following are some of VWAP's benefits: 

• The moving average is not as good as this indicator.
• It may suggest a trend that is bullish or negative.
• This signal is useful for both long and short positions.

Difference Between VWAP and a Moving Average

Plotting both indicators together on a chart could make them look identical. Both, nonetheless, differ greatly in terms of technicality. VWAP is computed using volume as an integral variable. In contrast, the moving average merely considers the price over a predetermined period and ignores the volume traded. Investors can adopt better-informed trading positions since VWAP in the share market additionally considers the volume traded.

What is Anchored VWAP?

The VWAP is calculated continuously from the start of the market opening to the closing. For various reasons, a trader may choose to set the starting point for computing VWAP at a time other than the open. This is when an anchored VWAP is employed. An anchored VWAP begins calculating from a user-selected beginning period. There are several reasons for utilizing an anchored VWAP, including attempting to normalize a price owing to a huge price difference up or down.

VWAP Trading Strategy 

• The volume-weighted average price (VWAP) is a useful indicator for identifying asset trends and market trends. 
• A price above VWAP indicates a bullish trend, while a price below it indicates a bearish market. This relationship can be used to make trades, with long positions taken when the price drops above the VWAP line, and short positions taken when it breaks under it.  
• Institutions use this to minimize market impact. With VWAP share India breakout stocks, traders can initiate long positions when the price breaks above the VWAP line, suggesting a potential uptrend, and short positions when the price breaks below the VWAP line, indicating a possible downtrend. 

Example of VWAP 

The normal price is the average of the high, low, and closing prices. You may compute it using the following formula: Typical Price (TP) = high price + low price + closing price/three.

Let's have a look at an example to help you grasp the computation. Let us imagine that the maximum price is 20, the lowest price is 10, and the average closing price is 15. Using the standard pricing calculation, we get TP = 20+10+15/3 = 15.

Then, multiply the TP by the volume. Assume the volume of the period is (V) = 20. Thus, TP*V equals 300.

Cumulative volume for the stock, which in this case is assumed to be = 75. So, VWAP = TP * V/CV = 300/75 = 4.

The VWAP may be calculated for each period, resulting in the creation of a curve on the price chart.

How to Trade with VWAP

Trading with the Volume Weighted Average Price (VWAP) can be highly effective, especially when combined with other indicators such as momentum indicators like the MACD or stochastic. 

Support and Resistance

A straightforward method to utilize VWAP is to identify support and resistance levels. When a stock's price is above VWAP, the line acts as a support level. Conversely, when the price is below VWAP, it serves as a resistance level. The direction of the VWAP line can also indicate the trend, functioning as a trend line.

Entry and Exit Points

VWAP can be instrumental in determining entry and exit points for trades. For instance, if a trader is long on a stock, they might use VWAP as an exit target if the price is below the VWAP. On the other hand, traders looking to enter a long position might wait for the stock to break above the VWAP or pull back to the VWAP and bounce off it. The VWAP, along with its upper and lower envelopes, can provide excellent entry and exit opportunities
 

Assessing Relative Strength

By observing a stock's position relative to the VWAP, traders can gauge its relative strength or weakness. Stock trading above its intraday VWAP typically indicates bullish behavior, while one trading below suggests bearish tendencies. Comparing the VWAP readings of benchmark indices and peer stocks can help determine if a stock is demonstrating relative strength or weakness. This insight is crucial, as shorting a stock above its VWAP in an uptrend might lead to a short squeeze, whereas shorting a stock below its VWAP in a downtrend aligns with the prevailing trend.

Trading VWAP Crosses

When a stock price crosses above the VWAP from below, it can signal a breakout, presenting a potential buying opportunity. Conversely, if the price drops below the VWAP, it may indicate a breakdown, suggesting a possible short-selling opportunity. VWAP is also useful for setting stop-loss levels. For instance, if you plan to enter a stock at a breakout price of $27.10 (the VWAP), you might set a trailing stop of $0.20 below the VWAP. This helps in creating a quantifiable strategy for your trades. Remember, VWAP is most effective when used alongside other indicators, especially those that measure momentum.

How To Interpret A VWAP Indicator

The Volume Weighted Average Price (VWAP) indicator offers traders essential insights into stock price movements. It helps identify key points within a timeframe where market momentum is evident. For instance, consider a trader dealing with a stock repeatedly failing to break above the VWAP line due to persistent selling pressure. The trader aims to pinpoint the exact moment the stock breaks above this line; otherwise, they risk taking a position contrary to market momentum by entering a short position prematurely.

VWAP Insights 

• Stocks below VWAP: These are seen as 'cheap' or 'undervalued,' suggesting a potential entry point for a short position.
• Stocks above VWAP: These are considered 'expensive,' indicating a potential sell signal.

Monitoring Price Movement

To determine when a stock price moves above or below the VWAP line, a technical system can integrate candlestick charts and trend lines. In a VWAP chart, the trend line functions similarly to support and resistance lines, with candlesticks showing price movements

Moving VWAP

The moving VWAP is a moving average line reflecting stock price movement relative to price. It tracks the end-of-day VWAP over time, and its time frame can be adjusted to include multiple VWAPs. It's crucial to note that VWAP and moving VWAP might not always align.

• VWAP Cross: This trading indicator appears when a stock price crosses the VWAP line.
• Trade Fill: Refers to executed orders related to buying or selling stocks.
• Typical Price Indicator: This represents an average of stock prices during the day, often used instead of the closing price to draw moving average price lines.

Calculating VWAP

The steps to calculate VWAP are as follows:

1. Calculate the Typical Price (TP) for each period by adding the high, low, and closing prices and dividing them by three: (H+L+C)/3(H + L + C) / 3(H+L+C)/3. Each candlestick represents a timeframe, such as 5 minutes or 30 minutes.
2. Multiply TP by Volume (V) for each period.
3. Divide the cumulative TP x Volume by the cumulative volume to get the VWAP.

This process yields the VWAP for each data point over a period. The moving VWAP averages these end-of-day VWAP values over several periods.

Using VWAP To Execute A Trade

VWAP, or Volume Weighted Average Price, is a crucial tool institutional investors employ to purchase large quantities of shares without causing significant market disruptions. But what does this entail? Let's break it down with an example.

Imagine a mutual fund looking to acquire 50,000 shares of a specific company. If the mutual fund places a single large order, it could trigger a surge in the market as the exchange attempts to fulfill this substantial demand. This would lead to an increase in the stock's price, prompting other traders to buy the stock at a higher price and potentially sell it at an even higher value. The mutual fund breaks down its total demand into smaller orders to prevent this scenario. By utilizing an automated trading strategy, the fund ensures that the purchase price remains close to the VWAP line, thus minimizing market impact and achieving a more favorable average price for the shares.

Limitations of VWAP

While the VWAP (Volume Weighted Average Price) is a useful tool for traders, it has several limitations that should be considered:

• Lagging Indicator: Being a lagging indicator, VWAP is predicated on historical volume and price data. Because of this, it reflects past trends rather than forecasting future price fluctuations. As a result, it might be less useful for predicting sudden changes in the market.
• Intra-Day Use Only: VWAP is updated at the beginning of every trading day and is mostly used as an intraday indicator. For longer-term assessments, it becomes irrelevant, and it is ineffective when used in multi-day trading methods. 
• Does Not Reflect Market Fundamentals: VWAP does not consider any fundamental issues that could impact a stock or index; it is solely a technical indicator. The VWAP computation does not take significant news releases, corporate earnings reports, or macroeconomic data into account.
• Volume Spikes Impact: Unexpected increases in trade volume may have a disproportionate impact on VWAP. For example, even though a huge deal at a high price may not reflect the wider market trend, it can skew the VWAP upward. Misleading signals may result from this.