Mastering the VWAP indicator: a comprehensive guide for traders

What is VWAP?

Volume weighted average price (VWAP) is a trading indicator that shows the true average price of a security. Unlike a simple average, it considers both price and volume. A VWAP trading strategy is a popular way for traders to use this indicator to find an asset’s fair value and potential entry points.

So, VWAP can be defined as the total value of a security traded in a specific period divided by the total volume traded in that same period. It is drawn as a single line on the price chart. This line represents the average price where most of the trading volume occurred.

VWAP is considered a more accurate average than a simple moving average (SMA). This is because it takes volume into account. A large-volume trade has a bigger impact on the VWAP line than a small-volume trade. This makes the VWAP line a better reflection of the ‘true’ average price for that day.

VWAP vs moving averages

The simple moving average (SMA) and exponential moving average (EMA) are based on price alone. They do not consider volume. SMA is a simple average of closing prices over a specific period, while EMA gives more weight to recent prices. VWAP, on the other hand, is anchored to the start of the trading session. It resets every day. SMA and EMA continue from the previous day’s data.

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How to calculate VWAP

Calculating the VWAP is a simple process. It involves only a few key steps. The basic formula is:

Let’s understand the VWAP calculation through a simple example:

Tools that calculate VWAP automatically

Most trading platforms have VWAP built in. You don’t need to calculate it manually. Platforms like TradingView and MetaTrader 4/5 do it for you automatically. You just need to add the indicator to your chart. It will then appear as a single line on the chart. This makes it easier to apply your VWAP trading strategy.

How VWAP works in trading

VWAP is an important tool for understanding market sentiment. It provides a visual guide for the day’s trend.

Market sentiment

The VWAP line represents the fair value of an asset for the day. Traders use it as a benchmark. If the price is above the VWAP, it means buyers are in control. They are willing to pay more than the average price. If the price is below the VWAP, it means sellers are in control and are selling for less than the average price.

When price is above vs below VWAP

When the price is above VWAP, it shows strength and is considered a bullish signal. It suggests a potential uptrend. When the price is below VWAP, it shows weakness and is a bearish signal. It suggests a potential downtrend. Traders can make entry and exit positions based on whether they see a bullish or bearish signal.

VWAP as dynamic support/resistance

The VWAP line often acts as a dynamic support and resistance level. In an uptrend, the price often pulls back to the VWAP line and bounces off it. This is support. In a downtrend, the price often rallies to the VWAP line and gets rejected. This is resistance. Traders can use these bounces to enter trades.

Learn more about entering and exiting positions and other trading essentials to strengthen your strategy.

Anchored VWAP: what is it and when to use it?

The traditional VWAP resets every day, but anchored VWAP is different. It is a permanent VWAP line that starts from a specific point chosen by the trader.

So, an anchored VWAP line begins its calculation at a specific point set by you. It continues to accumulate price and volume data from that point forward without resetting. This allows you to analyse long-term trends from a specific event.

Popular anchor points

Traders can anchor the VWAP to a major swing high or low. This shows the average price since the peak or trough. Another popular anchor point is a major news release or earnings report to check the average price since the event. Anchoring to a price gap shows the average price since the gap occurred.

Anchored VWAP strategy

Let’s understand the anchored VWAP trading strategy with an example. Imagine a trader who decides to anchor a VWAP to a major market low. They then watch to see if the price stays above this anchored VWAP line. As long as it does, the long-term trend remains bullish. A break below the line could signal a major trend reversal. The trade can be closed when such a breakout occurs.

VWAP vs other indicators

Understanding the differences between VWAP and other indicators is important to building your VWAP trading strategy. Here’s a look at the differences between VWAP and some of the most popular technical indicators.

VWAP vs SMA/EMA

VWAP vs MVWAP

MVWAP stands for moving volume weighted average price. It is a variation of VWAP. It does not reset every day. It is a VWAP over a specific lookback period, such as 20 bars. Unlike the standard VWAP, it can be used for longer-term analysis.

VWAP vs Bollinger bands

Bollinger bands are a volatility indicator. They are made up of 3 bands – a simple moving average, a band above this line, and a band below this line. The upper and lower bands are usually 2 standard deviations away from the SMA line. On the other hand, VWAP is a volume-weighted average. Traders often combine both these indicators to make trading decisions. This helps them understand both volume and volatility.

Learn more about the different indicators to strengthen your technical analysis.

Best VWAP trading strategies

Here is a guide on how to trade with VWAP using different strategies so that you choose one that suits your trading experience, psyche, and goals the best.

VWAP breakout strategy

A VWAP breakout strategy is a popular method to identify trading opportunities. To find the entry point, traders wait for the price to break and close strongly above or below the VWAP line. They then enter the trade on the breakout. For a long trade, the stop loss can be placed just below the VWAP, while for a short trade, it can be placed above.

It is best to confirm your decisions with volume or price action data. Look for high volume on the breakout. A strong, long candle on the breakout adds confidence.

VWAP pullback strategy

This strategy is used when a trend is already in place. In an uptrend, wait for the price to pull back to the VWAP line. Enter the trade on the bounce. In a downtrend, wait for a pullback to the VWAP line and enter on the rejection.

This strategy tends to offer a good risk/reward ratio. The stop-loss can be placed just below the VWAP. The profit target can be the recent high or a previous resistance level.

VWAP crossover strategy

This strategy combines VWAP with other moving averages. When a fast EMA crosses above the VWAP, it is considered a bullish signal. When a fast EMA crosses below the VWAP, it is taken as a bearish signal. For a long entry, traders usually wait for a 9-period EMA to cross above VWAP. This provides a clear, objective signal.

VWAP support and resistance strategy

This is a fundamental VWAP trading strategy. For this, you need to watch how the price interacts with the VWAP line. The price bouncing off the VWAP confirms the line as a support level. Rejections off the line confirm it as a resistance level. You can enter a long trade on a bounce and enter a short trade on a rejection.

Contrarian fade to VWAP

This strategy is based on mean reversion logic. Mean reversion means that an asset’s price tends to revert to its average over time. So, if the price moves too far from the VWAP, it is likely to snap back. A contrarian trader will fade a strong move away from the VWAP.

Combining the VWAP with Bollinger bands is a popular choice for this strategy. If the price goes outside the bands, it is considered a signal that the move is extended. A trader will look for a reversal back to the VWAP before placing their trade.

Learn more about different trading strategies to make an informed choice.

Combining VWAP with other indicators

To master a VWAP trading strategy, you must combine it with other tools. This is because no indicator is complete on its own. Confirming its signals with 1 or more other indicators increases confidence in the signal. Some of the most commonly used indicators with the VWAP include:

Relative strength index (RSI)

RSI is a momentum indicator that is popularly used to confirm a VWAP signal. When the price pulls back to the VWAP line, check the RSI. If the price is in an uptrend and the RSI is oversold (below 30), it is considered a strong buy signal. This confluence suggests that the pullback is temporary, and the trend will resume soon.

Moving average convergence divergence (MACD)

MACD shows the relationship between 2 moving averages. It helps identify a change in momentum. When the price breaks above the VWAP, look for a bullish MACD crossover to confirm the signal. This means the MACD line crosses above the signal line. Similarly, a bearish MACD crossover confirms a break below the VWAP, strengthening the trade idea.

Bollinger bands

Bollinger bands are a volatility indicator. When the price breaks out and moves far from the VWAP, it may be overextended. You can use Bollinger bands to confirm this. If the price touches the outer band, it suggests a potential reversal back to the mean (the VWAP line). This is commonly used for a contrarian VWAP trading strategy, fading the move back to the VWAP.

Pivot points

Pivot points are used to identify potential support and resistance levels. A VWAP support and resistance zone is more powerful when it aligns with a pivot point. If the VWAP line and a key pivot point, like S1 or R1, are at the same price, it creates a strong area of confluence. You can then enter a trade on a bounce or rejection from this combined level.

Trendlines

Trendlines show the direction of a trend. When a price is in a strong trend, the VWAP line often runs parallel to the trendline. If a price bounces off both the VWAP and the trendline at the same time, it provides a very strong buy or sell signal. This confirms that both the average price and the trend are moving in the same direction.

VWAP across market types

VWAP is most effective in specific trading environments.

VWAP resets every day. This makes it a key tool for intraday trading. However, this indicator is not suited for swing trading. For swing trading, an anchored VWAP tends to work better. Also, VWAP is most reliable in high-volume, liquid markets. In low-volume markets, the VWAP line can be choppy and less reliable.

Using VWAP with different assets

VWAP is especially popular in the stock market because volume data is very precise. Large institutional traders use VWAP to buy or sell massive orders without affecting the price too much.

In the forex market, volume data can be less centralised. However, many traders still use VWAP as a key indicator. It helps them identify intraday trends and fair value.

Popular strategies, such as the VWAP breakout strategy or using VWAP support and resistance, can be applied across asset types. However, you need to be mindful of liquidity differences and use VWAP in combination with other indicators for confirmation.

Learn more about trading different asset types with our market guides.

Benefits of VWAP trading

VWAP is a highly respected indicator since it gives the most accurate average price for the day. Plus, being a cold, hard number, it is an objective indicator. It is not subjective like a trendline. VWAP is very popular among large institutional traders. They use it to execute large orders without moving the market too much.

Limitations of using VWAP

Like all other indicators, VWAP has some key limitations. It is a lagging indicator, meaning it reflects past price action, not future. It is also a poor tool for analysing long-term trends because it resets daily. Plus, it can be less reliable in low-volume or sideways markets, where the price can stray far from the VWAP line. Lastly, relying on VWAP alone can lead to false signals. You must always confirm its signals with other indicators.

Common mistakes to avoid

Learning about the mistakes most commonly made while using a VWAP trading strategy can help you avoid them and minimise losses. Here’s a look.

• Ignoring volume context: the whole point of VWAP is volume. If you ignore the volume on a breakout, you could get a false signal.
• Over-reliance without confirmation: never trade with VWAP alone. Always confirm your signals with other indicators.

Learn more about risk management to bolster your trading strategy to mitigate losses.

Tools and platforms with VWAP

TradingView is a popular platform due to its rich features. It comes with built-in VWAP. It is easy to add and use the tool. You can also add custom scripts for anchored VWAP. The MetaTrader platforms (MT4, MT5) also have VWAP indicators available for download. They are very popular among forex traders.

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