VWAP Indicator – Day traders should be using it

By Shane Fry

Looking for the little extra edge with your trading, well look no further as the VWAP indicator is here and we have a customized a version for you to download FREE.  But first let’s walk through some of the benefits of using the VWAP and get a better understanding of what this indicator is.  In this article, I’m going to walk you through the main reasons why day traders are adding this valuable indicator to their trading arsenal.

What is VWAP?

VWAP stands for Volume Weighted Average Price and is used to identify the true average price of a stock or commodity by factoring volume into the equation. In essence the VWAP will appear on your chart as a moving average that is heavily weighted toward volume.  Volume is often the missing ingredient to trading success   The VWAP formula is: VWAP = ∑ Number of Shares brought x Share price ——————————————————————————- Total Shares Bought   The volume weighted average price (VWAP) is a trading measure used especially in purchasing stock. VWAP is calculated by adding up the dollars traded for every transaction (price multiplied by number of shares traded) and then dividing by the total shares traded for the day.  Day traders can use the VWAP to identify where the majority of the volume took place so it is a great visual clue as to where the market sees the value compared to price. In essence if traders purchases a stock, commodity or index below the VWAP that would be considered a good trade. Conversely, traders selling above the VWAP are considered to making a value trade.  

Identifying Momentum Moves Using The VWAP

The strength of moves based on volume can be pivotal to determining the value of a trading move. Is the commodity making a move to the daily high on heavy volume or are we seeing a volume spike with light volume pushing prices higher? Are we making new lows with very little volume? These questions are often overlooked by new or inexperienced traders. This is where the VWAP Indicator can give you great insight into the value of price movements based on the volume of a given period. We need to remember at this point that the VWAP is a day trading tool and resets at the end of the day.

Institutional Traders Use the VWAP

Institution traders use the VWAP to ensure they are buying and selling stock and or commodities at good value points. They like to scale in large orders around the VWAP because that is where the majority of the volume is occurring. They understand moving large orders into the market understand that their actions can impact the market.  Many fund managers and institution traders are benchmarked against the value of the VWAP throughout a trading session. For example if they are given a large order to execute in the market, their orders are assessed for value against the VWAP at the time of fill.

VWAP Indicator Can Identify Areas of Dynamic Support and Resistance

Figure 1: Crude Oil we have price testing and been rejected from the dynamic VWAP, therefore respecting VWAP Resistance

 Figure 1  

Figure 2: Soybeans we have price testing and been rejected from the dynamic VWAP, therefore respecting VWAP support

 Figure 2   If you are new to using support and resistance it’s time for a quick lesson in how this concept can really take your trading to the next level. Add in the ability for the VWAP find these areas dynamically and you are now trading with a recognizable edge in the market. Why does it work so well?  You will notice as you use the VWAP that it has a tendency to become more effective as support and resistance once the market starts to trend. What we are seeing here is that the volume is entering the market around the VWAP so it is a great tool to identify areas of buying and selling support.  This in part is caused by the institution traders who are trying to get large orders into the market around the VWAP. The VWAP help Day Traders to Buy Low and Sell High By knowing the volume average price of an instrument you can easily assess whether your trading opportunity is presenting good value as a buy or a sell entry.  

Figure 3: Price of EMD Compared to Its VWAP

fig 3 The key in this chart example is that we find the EMD trading below the VWAP indicator and you buy at market price, you are not paying more than the average price of the instrument for that given period.   A VWAP Cross Can Signal a Change in Market Bias As we see clearly in figure 3, crosses of the VWAP are a good signal for changes in the market trend for the timeframe you are trading. In the example prices closes above the VWAP to trade higher then reverses some time later to set up a nice close below the VWAP and a change in market direction. Conclusion Trading the VWAP in isolation will not produce the results that you may be expecting. With any indicator you need to ensure that you are using additional confirmation tools to validate your trading decisions. However, rather than just taking my word for it in the coming articles we are going to explore some of the trading strategies that can be used to trade the VWAP and compare their respective performances. For a free download of the VWAP please email shane@gmtfutures.com and we will send you your free VWAP indicator for Tradestation. Have a fantastic day.   Cheers   Shane