There are various technical indicators that have made the analysis of the financial markets remarkably easy. Some of them work with the objective of finding momentum. Others aim to find potential points of interest on a chart. But what is the most important aspect of technical analysis? It is the volume. It serves many purposes. Now, the indicators that capitalize on the power of volume are considered the most advantageous for technical analysis. In this article, we’ll go in-depth with the VWAP indicator.
- The Volume Weighted Average Price (VWAP) indicator is quite similar to a moving average in its look.
- The VWAP takes into account the volume for every bar so it can weight more prices where lots of traders traded.
- The VWAP is drawn on intraday charts as a single line.
- Intraday retail and professional traders may use it to determine intraday trends.
What is the VWAP?
The volume-weighted average price (VWAP) indicator is among such indicators that look to make the most of the volume. It is a technical analysis tool that calculates the true average price of a financial asset weighted by volume for a predefined period of time. The incorporation of volume into the average price of a stock is the real strength of the volume-weighted average price (VWAP). Analysts and traders value the strength of the VWAP.
Basically, it illustrates the average price of a financial asset based on the trading activity at different prices usually within a timeframe of one day. Its display on a chart looks similar to a moving average display but its movement remains much slower. The VWAP often acts as a benchmark price to measure the overpaying or underpaying ratios for their shares as compared to anyone else. Therefore, the VWAP indicator is one of the most widely accepted and used indicators with numerous advantages for day traders. It has the ability to demonstrate whether the traders who recently started trading are taking profits or losing money on their trades.
The calculations and formula of the Volume-Weighted Average Price (VWAP) indicator
The volume-weighted average price (VWAP) indicator calculates the average price on a daily basis. It starts functioning with the opening of the market and stops functioning when the market closes. Therefore, it uses intraday data for calculations. Most of the modern trading platforms plot the volume-weighted average price (VWAP) indicator on a chart online and automatically calculate all the calculations for you.
The formula of the Volume-Weighted Average Price (VWAP) indicator is very simple and straightforward. It is as follows:
Volume weighted average price (VWAP) = (Typical price of the stock + volume) / Cumulative volume)
Where: Typical price = (Highest price + lowest price + closing price) / 3
What does the VWAP indicator tell traders?
The volume-weighted average price (VWAP) is used as a benchmark for the current market position by passive traders who prefer long-term investment plans. A most common and simple strategy is to buy financial instruments at a lower price than the VWAP. Most of the traders use a higher price than the VWAP as a sign to initiate a trade. They get into a long trading position when the price crosses the threshold of the VWAP. Conversely, they prefer a short position when the price goes below the VWAP threshold.
Similarly, the VWAP indicator also tells about the bullish and bearish trends in the market. The price above the VWAP indicates a bullish trend while the below level shows the bearish trend. However, it is important to take the context of the market into consideration before initiating a move.
The volume-weighted average price (VWAP) indicator also reveals the areas of liquidity to help large organizations to enter or exit large trades. It also works as a gauge to measure the efficiency of trade executions. To sum up the debate, the volume-weighted average price indicator is an indicator that serves many purposes for analysts, traders, and large institutions.
How to use the Volume-Weighted Average Price indicator?
The use of the volume-weighted average price (VWAP) is very similar to the moving average line. A falling VWAP indicates a price downtrend. Conversely, a price uptrend appears with a rising VWAP. As it continues the calculations from opening minutes to the closing of the financial market, it is used as a support and resistance line.
The volume-weighted average price (VWAP) indicator has made its way into several algorithms and highly efficient trading programs. You should not be surprised if you receive a VWAP guaranteed offer from a broker. Moreover, investors use it as a passive tool to buy shares at a reasonable price. This reasonableness is calculated subsequently by the magnitude of the bounce above the VWAP. It is very crucial to keep in mind that today’s good price may become a very lousy price tomorrow. It is due to the fact the VWAP begins new calculations each day.
The volume-weighted average price (VWAP) has also become a gauge to measure trading efficiency. After buying or selling a financial asset, institutions or individual traders compare their buying or selling prices with the values of the VWAP. A buying price below the VWAP price indicates a favorable buy because buying price is below the average market price. Similarly, a selling price above the VWAP shows a favorable transaction because the selling price is higher than the average market price.
Traders also use it to find out about liquidity points. It calculates price levels weighted by volumes that help institutions that trade in large volumes. The VWAP helps such institutions to find out the liquid and illiquid points for a particular financial asset over a short period of time.
Advantages and disadvantages of the VWAP indicator
As it is evident from the debate that the volume-weighted average price (VWAP) is among the most influential analysis tools. It has several advantages such as:
- It is the best tool for day traders to measure the efficiency of their trades.
- Algorithm trading tools make the best use volume-weighted average price (VWAP) ratios to help investors calculate the prices to buy or sell their financial assets.
- It is also very helpful when large volumes of shares of a single stock. The VWAP ensures investors that such a large buying will overinflate the prices of their desired stock.
- It helps institutional buyers to plan entries and taking long positions to remain on the right side by allowing them to make the right decisions at the right times.
However, like the rest of the indicators, the volume-weighted average price (VWAP) has also certain limitations. There are particular issues with the VWAP traders must account for.
- The response rate of the VWAP indicator is quite low during the later hours of the day. It has to deal with a huge amount of data that continues to grow throughout the day. This issue causes the VWAP to lag.
- It is only useful for intraday trading. It is not possible to calculate the VWAP over two or more days.
- The VWAP does not possess predictive quality because it relies on past data.
The volume-weighted average price (VWAP) helps to calculate the average price of an asset-weighted by the volume over a given period. It continues its calculations throughout the day. It is a very useful intraday trading tool that helps to enter or exit the trading position and potential entry or exit points. Despite its power and advantages, it cannot be used in isolation. Therefore, technical analysts and experts stress using the volume-weighted average price (VWAP) indicator in conjunction with other reliable indicators for confirmation.