VWAP

Lets dive into Volume Weighted Average Price i.e. VWAP.

Table of Contents

• VWAP
  • Basic Logic
  • Standard Deviations
  • VWAP usage by Institution
  • VWAP – How to use ?
• VWAP – Accumulation Setup*
• VWAP – Trend Setup*
• VWAP – Calculation Period
• VWAP – Let it develop
• VWAP – Prev. session values
• VWAP + Volume Profile

VWAP

• One of the most commonly used algorithm of big trading institutions is Standard Average, BUT weighted by volume (= prices where big volumes got traded, are more important)
• All trading instruments.
• All time frames.

VWAP Line

Basic Logic

• Institutions want to BUY CHEAP & SELL EXPENSIVE
• Institutions are looking for a
• BUY when Price is BELOW VWAP, and for a
• SELL when Price is ABOVE VWAP.
• AND VICE VERSA:
• Institutions are
• NOT looking for a SELL when Price is BELOW VWAP, &
• NOT looking for a BUY when Price is ABOVE VWAP.
• Price should return to VWAP.
• It works as a magnet.
• Institutional algorithms are usually set to execute trades close to VWAP.

Standard Deviations

VWAP with Standard Deviations

• In above chart Indicator shows 1st and 2nd standard deviation of VWAP.
• More responsive than VWAP.
• Show nicely if there is a TREND or a ROTATION.
• Deviations = Support & Resistance zones.
• In Rotation as well as in Trend market development.

VWAP usage by Institution

When an Institution has large orders that must be filled they will often use a VWAP based algorithm to execute the order as close to VWAP as possible. By executing their order as close to VWAP as possible it indicates that they have been able to minimize the market impact of their order. Hedge funds are conscious of their market impact costs which are the costs incurred by trades so big that they will move the market.

In a simple form VWAP is used to determine value for institutional traders much in the same way a moving average works as a trading indicator. But VWAP is used more for trade analysis than trade entry. When a buy order is filled at a price better than VWAP it is good for the trader as the average transaction value is better than what everyone else in market for that time period also received. The reverse is also true for when one is selling. If a sell order is filled at a price better than VWAP the trader is selling at a higher average price than everyone else during that time period. VWAP is the measuring stick for large orders.

When price is below VWAP, institutions that are looking to buy will tend to buy at prices below VWAP as they are able to build a position that is better than the VWAP. They won’t be that willing to buy when the price is trading above VWAP as it will ruin their own average price against VWAP.

When price is above VWAP, institutions that are looking to sell or get short will try to execute their orders as they are selling at prices that they feel are better than what has been recently trading. If an institution is trying to fill an order they won’t be as willing to buy when price is trading above VWAP, they may buy some just to participate in case price never comes back to VWAP, but it will be minimal.

The interesting thing about VWAP orders is that there is no guarantee that it will be filled or that it will match VWAP.

So why is VWAP important? For an intraday trader VWAP is important because they can determine if they are selling too cheap or buying to rich. When prices start moving 1 or 2 standard deviations above VWAP and you are buying you could be buying at prices too expensive. Conversely, if you are selling and prices are 2 standard deviations below VWAP you could very well be selling too cheap. This is not to say that prices cannot move 3 and even 4 standard deviations away from VWAP because it can.

When trading with S-R plus Volume Profile zones you can lay VWAP lines on your chart to give you an indication if it trading cheap or rich. I am more prone to take buy signals when the market is trading cheap and sell signals when the market is trading rich to VWAP.

Do not think for a minute that VWAP has to revert to the mean. A market can stay above or below VWAP most of the day.

• VWAP is not without its limitations. As the trading day goes on the lag in VWAP become stronger.
• This is because a lot of trade data has already been factored in and new trade data has less of an impact on the overall VWAP number and will tend to flatten out.
• On strong trending days price will be above or below VWAP pretty much all day.
• On range trading days VWAP will run through the middle of price action.
• On days when important news comes into the market late in the day, that cause significant price movements on heavy volume the VWAP profile will be affected.
• How an order is executed will also affect the VWAP since the average execution sits somewhere between the bid and offer spread.
• To match VWAP an order would need to be a combination of limit orders and market orders.

Don’t be misled into thinking that VWAP is a new excellent indicator to take trades against. As I mentioned earlier, VWAP is a way to measure a broker’s trade execution. Traders make money by buying low and selling high, not by beating VWAP.

VWAP – How to use ?

• Use VWAP as a Take Profit (works like a magnet).
• Use Standard Deviations to identify rotation/trend.
• Use Standard Deviations as Support & Resistance zones.

VWAP – Accumulation Setup*

VWAP Accumulation Setup

• Identify a accumulation (VWAP and deviations go sideways)
• SHORT when price goes up and hits VWAP from below
• LONG when price goes down and hits 2nd deviation from above
• A viable Take Profit is VWAP line*

VWAP – Trend Setup*

VWAP – In Downtrend

• Identify a trend (for example using VWAP deviations)
• In Downtrend:
• wait for pullback to 1st deviation or VWAP line.
• Go SHORT.

VWAP – In Uptrend

• Identify a trend (for example using VWAP deviations)
• In Uptrend:
• wait for pullback to 1st deviation or VWAP line.
• Go LONG.

VWAP – Calculation Period

VWAP Settings

• A new VWAP gets calculated every Day (or week, month, year).
• Intraday trading: Daily, Weekly, Monthly plots
• Swing trading: Monthly, Yearly plots
• Long–term trading: Yearly plots

Intraday VWAP – Top weekly plot, Bottom daily plot

VWAP – Let it develop

• Wait until VWAP and its deviations develop before using it to create trading levels (roughly):
  1. Daily VWAP – 5 hours (2h)
  2. Weekly VWAP – 2 days (1.5d)
  3. Monthly VWAP – 10 days (7d)
  4. Yearly VWAP – 2 months (1.5m)

VWAP – Prev. session values

Above Chart VWAP previous years line act as resistance and support.

• Work as additional Support and Resistance zones.
• Use only as a confirmation. Not as standalone trading levels.

VWAP + Volume Profile

• VWAP setups are a good standalone strategy BUT shine most when used with Volume Profile.
• Volume Accumulation Setup or Volume Trend Setup combined with VWAP deviation form a strong long intraday support level.

Volume Profile and Fibonacci Confluence

Additional VWAP Confluence at same area

That’s a wrap for Volume 5 next up is Volume 6: YOUR TRADING BUSINESS. Will explore articles related to it. Keep Practicing.