he VWAP is a strong, all-encompassing indicator of trading that really unlocks unique insights into the market. When utilized correctly, it can help refine your strategy and make better decisions.
In this article, we look at what VWAP is, how it works, its best strategies, and how to set up the optimal anchor period and settings for different trading scenarios.
What is the VWAP Indicator?
VWAP is the average price of a security, weighted by volume, over a given period. It is calculated by dividing the total value of trades by the total volume of trades within a selected time frame.
The VWAP indicator typically consists of three components:
- The VWAP Line (Middle Line): It plots the volume-weighted average price.
- Standard Deviation Bands-U and L: These show overbought and oversold levels.
Unlike moving averages, VWAP is “anchored” to a specific period and hence is much more stable, in context for intraday analysis and for the day trader.
How does the VWAP work?
Unlike moving averages, VWAP is not a sliding calculation over a fixed number of bars but rather one that always recalculates from the beginning of an anchor period. Because of this, it’s highly sensitive to the chosen timeframe and trading session.
Key Points:
- Anchor Period: The period from which VWAP starts the calculation. The usual options are session, week, or custom periods.
- The greater reactivity in the price of the VWAP at the beginning part of the anchor period emanates from the fewer numbers of data points involved during this anchoring period. It gets less and less responsive as time goes on.
- Weighted by Volume: The larger the trade, the greater its effect on the VWAP, and it is because of this that the VWAP enjoys a very practical advantage over simple averages.
Anchor Period and Time Frame Settings
The anchor period is vital in how VWAP works; it defines the times when the Calculation resets:
- Session-Based VWAP [DEFAULT]: Resets at the beginning of each trading session. Best for intraday traders on 1-minute to hour charts.
- Weekly VWAP: This resets at the start of each week. It serves useful to swing traders because it gives multi-day views.
- Custom Anchor Periods: Personalized settings that allow someone to fashion unique trading plans, even monthly VWAP for general trends.
Time Frame Considerations
The appearance of VWAP depends on the chosen chart time frame. For example:
- On the daily charts, the session-based VWAP will hardly deviate from the Daily candlestick and may begin to take on the general appearance of a moving average.
- On shorter time frames-from 5-minute charts, for example-VWAP gives an indication of where price is in relation to volume that is much clearer.
Best VWAP Trading Strategies
1. Mean Reversion Strategy
That’s because VWAP acts like a magnet to price in range-bound markets; the tendency of prices is to revert toward the VWAP. So, it works great with mean reversion sets.
How to Use:
- Identify Extremes: The use of bands of standard deviation to define levels of overbought and oversold.
- Reversion Entry Points:
- Overbought: Prices reach the upper band sell or short.
- Oversold: The point to buy when the price approaches the lower band.
- Confirmation: Check for formations in candlestick patterns or volume that confirm your trading idea.
2. Strategy of Trend Confirmation
In trending markets, VWAP can be used to confirm momentum and give an indication of market direction.
How to Use:
- Bullish Trend: Price remains above the VWAP. Look for pullbacks near the VWAP line to enter long positions.
- Bearish Trend: Price stays below the VWAP. Look for a retracement to get nearer to the VWAP line to open short positions.
- Standard Deviation Bands: Wider bands are also used to determine breakout levels or potential exhaustion of the trend using 2x or 3x multipliers of the standard deviation.
3. Volume Confirmation
VWAP accounts for volume, which makes it perfect for measuring institutional activity.
- High volume near VWAP often marks strong areas of support or resistance.
- Low volume with price deviation from VWAP gives false moves.
Advantages of VWAP
- Volume Sensitivity: It will better reflect the average, as price is weighted in accordance with volume traded.
- Anchoring Session: Provides insights of context, as it is reset with every trading period.
- Versatile Strategies: Can be used for mean reversion, trend following, and breakout trading.
VWAP Settings Customization
- Standard Deviation Bands: Change multipliers based on selected sensitivity levels: 2x and 3x.
- Anchor Periods: Select session, weekly, or custom periods, whichever fits your trading style.
- Color and Line Thickness: Customize for better visibility on your chart.
Common Mistakes to Avoid
- Ignoring anchor periods can distort the VWAP calculations and mislead a trade.
- Over-reliance on VWAP Alone: Combine with other indicators like RSI or MACD for stronger confirmation.
- Trades against strong trends: Mean reversion setups can fail completely in a heavily trending market.
Conclusion
The VWAP remains one of the most dynamic and integral tools for every trader because it expresses price, volume, and ultimately market trends.
Know its calculation, anchor period, and strategic applications-the very core of how best to leverage VWAP in empowering your trading decisions. All traders, be it day traders or swing traders, can use VWAP as a leading edge in the markets once mastered.
Keep changing the settings and strategy to suit your trading style and always backtest before implementation.
