The volume-weighted average price (VWAP) is a trading benchmark used by day traders who want to make sure they’re getting the best possible price based on trading volume for their trades. It’s also a useful tool for day traders, who can use it to gauge market momentum and make decisions about when to enter and exit trades. This lesson will show you how to use VWAP for day trading.
What is VWAP?
Volume Weighted Average Price, commonly referred to as VWAP, is a trading indicator used by day traders that gives the average price of a security based on its cumulative volume. The VWAP calculation is executed using all the traded prices of a security during a particular time period, and weighting them according to their respective trading volumes.
Why is VWAP Important?
It is important to understand volume-weighted average price and its importance as a popular tool among day traders and other short-term market participants. VWAP is popular because it takes into account both cumulative price and cumulative volume during the trading day.
This makes it a more accurate measure of market momentum than price alone. It can be used as a reference point to assess whether a security is being bought or sold at a good price, or to help time entry and exit points in trades.
How is Volume Weighted Average Price Calculated?
In order to calculate VWAP, you need to know the volume and price of each trade that takes place during the trading day.
There are a few different ways to calculate the volume-weighted average price. The most common method is to take the sum of all traded prices multiplied by the number of shares traded at each price, divided by the total number of shares traded.
VWAP = (Σ(Price * Number of Shares Traded)) / Σ(Number of Shares Traded)
For example, let’s say that the following trades have occurred:
Trade 1: 100 shares at $10
Trade 2: 200 shares at $20
Trade 3: 300 shares at $30
The VWAP would be calculated as follows:
VWAP = ((100 10) + (200 20) + (300 * 30)) / (100 + 200 + 300)
= $20
As you can see, the VWAP is simply the weighted average of the prices of all the trades that have occurred.
Using Price to Create the VWAP Line
As described above in technical terms, the VWAP indicator line is created by taking the sum of all traded prices multiplied by the number of shares traded at each price, divided by the total number of shares traded. This calculation is done for each period (usually each minute) and then plotted on a chart.
To help beginner day traders understand volume weighted average price VWAP in simpler terms for their trading strategy, the VWAP line is a useful tool for day traders because it can be used to gauge stock market momentum within a trending market and specific time frame. If the price is above the VWAP line, it means that the market is bullish and prices are rising. If the price is below the VWAP line, it means that the market is bearish and prices are falling.
The VWAP line can also be used as a target to take profits or a stop-loss level. If the stock price is rising and hits the VWAP line, it’s a good time to take profits. If the price is falling and hits the VWAP line, it’s a good time to exit your position.
In terms of time frame, it’s important to remember that the VWAP line can change throughout the day as more trades are executed. This means that you’ll need to constantly monitor the VWAP line if you’re using it as a target or stop-loss.
VWAP Trading Strategies
There are several trading strategies that depend on an understanding of the VWAP indicator, two of which are described below.
Profit Target
Some traders use VWAP as a target to take profits because it represents the true average price paid by all traders. This makes it a good level, i.e., price target, to take profits, as it’s unlikely that the price will continue rising beyond this point.
Stop-Loss
Other traders use VWAP as a stop-loss level because it represents the average price paid by all traders. This makes it a good level to exit your position, as the price is unlikely to fall below this point.
Some traders even use VWAP as both a profit target and a stop-loss. This can be a successful strategy, but it’s important to remember that you’re more likely to get stopped out if you use VWAP as your only stop-loss level.
It’s also worth noting that Volume-Weighted Average Price can change throughout the day as more trades are executed. This means that you’ll need to constantly monitor the VWAP level if you’re using it as a target or stop-loss.
Other Technical Indicators to Use with VWAP
There are a few other technical indicators that traders often use in conjunction with the VWAP indicator within an intraday time frame. These include moving averages, Bollinger Bands, and MACD.
Moving Averages
This indicator can be used to help identify the price action, price trend, and price target. If the market is trading above the 200-day moving average, then it’s in an uptrend. If the market is trading below the 200-day moving average, then it’s in a downtrend.
Bollinger Bands
Bollinger Bands can be used to measure market volatility, i.e., market noise. If the market is trading near the upper Bollinger Band, then it’s said to be more volatile. If the market is trading near the lower Bollinger Band, then it’s said to be less volatile.
MACD
MACD is a momentum indicator that can be used to identify trend changes. If the MACD line is above the signal line, then it’s said to be in an uptrend. If the MACD line is below the signal line, then it’s said to be in a downtrend.
Divergences
When using these technical indicators with VWAP, traders will often look for divergences in price action. A bullish divergence occurs when the market makes a lower low but VWAP makes a higher low. This is seen as a sign that the market may be about to turn around and start moving up.
A bearish divergence occurs when the market makes a higher high but VWAP makes a lower high. This is seen as a sign that the market may be about to turn around and start moving down.
Remember, these are just a few of the many technical indicators that traders use. It’s important to experiment with different indicators to see which ones work best for you and your VWAP trading style.
Summary: VWAP for Day Trading
The lesson above attempts to help intraday traders understand the VWAP indicator in their day trading activities. We have covered the importance of VWAP trading, how the VWAP indicator is calculated using price action to create a line, key trading strategies, and ways to incorporate VWAP with other technical indicators.
As a key takeaway, remember that VWAP is a ratio of the cumulative price to cumulative volume over time. VWAP uses intraday data as a benchmark for comparing trade executions.
Since VWAP can change throughout the trading day as more trades are executed, you will need to constantly monitor the VWAP level if you’re using it as a target or stop-loss.
To Learn More
Maurice Kenny has helped over 600 people understand technical indicators, such as VWAP, and become financially free through one-on-one coaching, mentorship, and options trading strategy. Many traders are now full-time day traders, and they all started by watching his 1-hr webinar.
Feel free to check out other FREE educational resources to help guide you as you begin your new journey to financial freedom.
Also, download a (FREE E-BOOK) by Maurice Kenny, “DAY TRADE LIKE A MILLIONAIRE.”
