Indicator Explained: Volume Weighted Average Price (VWAP)

VWAP identifies the true average price of a stock by factoring the volume of transactions at a specific price point and not simply based on the closing price. It reacts to price movements based on the volume during a given period.

Reasons To Love the VWAP

1: VWAP Calculation Factors in Volume
2: VWAP Can Enable Buy Low and Sell High

If you find the stock price is trading below the VWAP indicator and you buy the stock at market price, you are not paying more than the average price of the stock for that given period.

3: A VWAP Cross Can Signal a Change in Market Bias

A VWAP strategy called the VWAP cross can help you locate and trade momentum in the market.

Since the VWAP indicator resembles an equilibrium price in the market,

- When the price crosses above the VWAP line, you can interpret this as a signal that the momentum is going up and traders are willing to pay more money to acquire shares.

- When you find the price is crossing below the VWAP, you can consider this as a signal that the momentum is bearish and act accordingly.

4: VWAP Can Act as Dynamic Support and Resistance
5: VWAP Can Help You Confirm Counter Trend Trading Opportunities

If you are just looking at the RSI or Stochastics and double guessing if this is a strong trend or the market will turn back, then adding the VWAP indicator on your chart can make your life much easier.

VWAP Setups

2 basic setups:

(1) Pullback or

(2) Breakout (break above the VWAP itself with strength)

VWAP Pullback Entry

  • You are not buying at the Highs of the day, so you lower the distance from your entry to, let’s say the morning gap. Thus reducing the amount of money you are risking on the trade if you were to just buy the breakout blindly.

  • Also, you are able to monitor and “size up” the trading activity as the stock shifts back and forth trying to find its footing at the VWAP. This will allow you to maybe look at 2 to 4 bars before deciding to pull the trigger.

  • You can then begin to watch the volume to see if the selling on the pullback is purely technical or if there is real danger on the horizon. Volume to me is the lens you can apply to the market, which can make sense of all the chaos and noise. The key thing you want to see is price increase with significant volume

  • Things can stay sideways for a considerable amount of time.

Entry Option 1 – Aggressive Traders

- Watching the price action as it is approaching the VWAP

- Wait for a break of the VWAP and then look at the tape action on the time and sales

- Identify when the selling pressure is spiking and the tape is going crazy. The goal is to identify when the selling pressure is likely to subside and then enter the trade.

- Example: if the VWAP was at $10, place LO at $10

Entry Option 2 – Risk Averse Traders

- wait for the stock to test the VWAP to the downside

- look for the stock to close above the VWAP

- place buy order above the high of the candle that closed above the VWAP

VWAP Stop: Pullback Stop is the most recent low point.

VWAP Target: Selling at a Fibonacci Extension Level

Example 1 - VWAP Pullback Trade

Example 2 - VWAP Breakout Trade

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