VWAP (Volume Weighted Average Price)
The Volume Weighted Average Price (VWAP) is a trading benchmark that shows the average price a security has traded at throughout the day, based on both volume and price. It provides traders with insight into both the trend and value of a security.
Formula
VWAP = Σ(Price × Volume) / Σ(Volume)
Where:
Price = Typical Price (High + Low + Close) / 3
Volume = Trading volume for the period
How VWAP Works
VWAP combines price and volume data to show where most trading activity occurred at each price level. It's particularly useful for intraday trading as it resets each day. Institutional traders use VWAP to help determine the quality of execution, while individual traders use it to identify potential support and resistance levels and trend direction.
Trading Strategies Using VWAP
Strategy Examples
- Buy when price crosses above VWAP from below
- Sell when price crosses below VWAP from above
- Use VWAP as a target price for entries and exits
- Trade mean reversion when price deviates significantly from VWAP
- Combine with other indicators for confirmation
Support and Resistance
- VWAP acts as a dynamic support/resistance level
- Price tends to revert to VWAP after significant deviations
- Multiple timeframe VWAP creates strong S/R zones
- Standard deviation bands around VWAP show potential reversal areas
- High volume nodes near VWAP strengthen support/resistance
Trend Identification
- Price above VWAP indicates bullish trend
- Price below VWAP suggests bearish trend
- VWAP slope shows trend direction and strength
- Multiple crosses of VWAP indicate choppy market
- Distance from VWAP shows trend momentum
Advantages and Limitations
Advantages
- Incorporates both price and volume data
- Provides objective reference price
- Helps identify institutional trading levels
- Useful for both entry and exit decisions
Limitations
- Resets daily, limiting longer-term analysis
- May lag in fast-moving markets
- Less effective in low volume conditions
- Requires real-time data for accurate calculations
Best Practices
Using VWAP Effectively
- Use VWAP primarily for intraday trading decisions
- Wait for price to test VWAP before entering trades
- Combine with volume analysis for stronger signals
- Monitor multiple timeframe VWAP for better context
- Consider market conditions when interpreting VWAP signals
- Use standard deviation bands to gauge volatility
- Look for price/VWAP divergence patterns
- Document which VWAP strategies work best for your style
- Scale positions based on distance from VWAP
- Be patient waiting for high-probability VWAP setups
- Use tighter stops when price is near VWAP
- Implement wider stops during volatile periods
- Consider time of day when using VWAP
- Monitor volume patterns around VWAP levels
Risk Management Guidelines
- Maintain consistent position sizing rules
- Use VWAP deviation to adjust stop distances
- Consider partial profits at extreme VWAP deviations
- Implement trailing stops in strong trends
- Reduce exposure during low-volume periods
- Monitor sector/market VWAP for overall risk assessment
- Keep detailed trading records to optimize performance
- Always use stop-loss orders to protect capital