Technical analysis is an integral part of trading stocks. Math-backed analysis and research are what make trading more than just sheer luck. Day traders use different mathematical and statistical tools for this analysis.
Volume weighted average price indicator or VWAP indicator is one such tool. Like moving average, a volume-weighted price chart is populated with average prices but with volume weightage.
Forming intraday trading strategies
Intraday trading is way trickier and riskier than regular stock market trading. A day trader tries to take advantage of market volatility to reap profits. But sometimes, violent price swings could end up helping you garner a significant profit or suffer a significant loss.
Hence, it becomes crucial for newbie day traders to learn to formulate day trading plans with tools such as the VWAP trading indicator before they become short-term traders.
Let us learn more about VWAP indicators and how it helps a day trader form a trading strategy.
What is the VWAP indicator?
Volume weighted average price is an intraday price chart representing the average equity price in set intervals. It is represented by a single line similar to a moving average line but much smoother.
Above is the picture of a price chart of reliance industries’ price movement on a particular day. Along with the price movement, you can see a red line across the chart in the chart. This is the WVAP line, and it represents the stock’s average price throughout the day at different times.
Therefore, this WVAP line can be used as an indicator in determining how the stock’s current price is performing in accordance with the average price of a stock.
A WVAP indicator provides valuable information regarding two things – a stock’s trend and value. Day traders can use the same to decide on their short trades. For instance, if the VWAP indicator confirms an uptrend, intraday traders can use the confirmation to carry out trades accordingly. VWAP values could also be used as a trend-confirming tool.
The goal of the volume-weighted average price
A volume-weighted average price line primarily represents the price action of a particular stock throughout the day. Day traders can use the same price line to decide on their short trades and confirm trend direction.
A VWAP indicator is strictly used in short trades only. It can only confirm or identify trends during a short time frame. It works best when used in time intervals of five minutes or less.
A volume-weighted average price and a moving average are similar indicators that indicate the average price action of a stock. But VWAP indicator has the edge over the moving average in one aspect. Let us see what it is.
Difference between VWAP & Moving averages
The main difference between a volume-weighted average price and a moving average is the inclusion of volume in the calculation. A moving average could help identify the trends but it does not take the volume of trades into consideration.
Read more: Types of Moving Averages
On the other hand, a volume-weighted average price comes at an average price by considering both the stock price and volume of trades. This can help investors make trading strategies in a much more informed environment. Take a look at the two charts below.
The first chart represents the moving average price.
The second image represents the VWAP chart of TATA steel on the same day during the same time frame.
As you can see, the volume-weighted average price line is much smoother than the moving average price.
The importance of volume in VWAP Indicator
The above difference in price line is due to the consideration of trading volume in the VWAP chart. Volume gives a better perspective of the trending market.
In the absence of volume, the chart can be misread and could lead way to incorrect trades. For instance, if the volume is low during a session of day trading, one or two trades could define the line.
Quick read: Trading volume analysis
This can sometimes be interpreted wrong. Traders also employ strategies like stop-loss orders using these tools. On those occasions, such a market noise could trigger the order in the wrong situation, and it could result in a loss.
Calculating volume-weighted average price
As mentioned above, the VWAP indicator line is calculated by taking the average price action, considering the volume weightage as well.
Most modern charts have a VWAP indicators addon, but calculating WVAP on your own will better help you understand the same. You can create a WVAP price action line by following the below steps.
A VWAP chart can be formed in any required time frame but it works the best when the time interval is shorter. Here, let us make a chart with five-minute intervals.
For this, first, you have to find the stock’s average price in the first five minutes of the day. To do this, find the interval’s higher band, lower band, and closing price and divide it by three.
Then create a column PV in a spreadsheet and record the value after multiplying the above average by the trade volume in the fields.
To create a WVAP line, add the value of PV by the total volume of a specific period. This will produce a WVAP line.
To keep up the data point current, keep adding PV values of each period to the current value. Keep dividing this value by total volume till that point.
Application of VWAP Indicator
VWAP indicator gives you the average price of stocks throughout the period of the day. Intraday traders can use this information for different things. A complex number such as VWAP can be used in many nontraditional ways as well. But below are some of the most common uses of a VWAP line.
Identifying trends: Volume-weighted average price is primarily used to identify trends. A stock’s price going above the VWAP line could indicate an uptrend, while a price going below the WVAP line could indicate a downtrend.
Support and resistance: VWAP line is also a technical indicator used to identify support and resistance levels. Support and resistance points are pivot points in an intraday chart where the stock prices tend to pause or show price reversals.
Since the VWAP line indicates an average, the line itself can be a support and resistance point. On occasions like this, the price could shy away from a VWAP cross.
Setting stop-loss: Stop-loss orders are agreements with a broker to buy or sell a stock once its price crosses a certain level. A VWAP line can be used for the same to avoid losses. For instance, you can set for trade executions once the price crosses the VWAP line. This VWAP strategy helps minimize the risk involved.
1. Analyzing trends Using VWAP Indicator
Now that you have understood the applications of VWAP let us put it to the test on a practical level. As seen in the example above, charts with candles give you much more information about the VWAP line. It can complement your VWAP trading strategy with more insights into price action. Below is what a candlestick would look like.
Each candle denotes the chosen interval’s price differences. For VWAP, 5 minutes intervals are mainly used. Here, a candle would denote the price movement in five minutes.
A long candle means there is a higher difference between the starting price and the closing price of the five-minute interval. Here, a red candle would denote a drop, while green denotes a rise.
Short candle denotes a shorter price difference in the set interval.
Apart from these, different candlestick patterns indicate different trends. Since VWAP charts work best with candlesticks, it is helpful to understand different patterns like marubozu, Doji etc.
Uptrend analysis
The above is a price chart with the VWAP line of Power Grid Corporation of India Limited on a particular day. Pay attention to the area marked by the yellow arrow. There, you can see that the price has crossed the VWAP line and continues to stay above the VWAP line, indicating an uptrend.
One important thing to understand here is that the cross must be potent. Here, you can see that there are two strong green candles after the red one.
Suppose, as a day trader, if you have bought the stock when the second green candle (Marked by the yellow arrow) had formed, you could have made a profit. You could also take a long position in the stock. The decision on what to do with the information VWAP gives you should be based on several factors, including economics.
Downtrend analysis
imageThis is how Adani Power opened on the stock market on 24th May 2022. Take a look at the area on the chart denoted by the yellow arrow. Unlike in the above example, we can see the price crossing the WVAP line downwards and the price staying below the WVAP indicator ever since.
You can use this information in multiple ways. For instance, you can sell your stocks at the point where the WVAP is met to avoid losses or take a short position. Here too, waiting for a strong indicator of a trend can help you avoid miscalculations.
Sometimes, a price below the average can also indicate an underrated stock. Proper analysis of the company can help you identify such cases. This information can then be used to employ strategies to gain when the price rises to its intrinsic value.
2. Support and resistance analysis
As we have discussed above, the WVAP line tends to support and resist the stock price. Look at the chart of Hero MotoCorp above. You can see the price hovering around the WVAP line.
This support and resistance prevent the stock price from rising or dropping too much from the average price, helping avoid volatility.
3. Stop-loss analysis
A stop-loss order is used to minimize the loss when a stock turns bearish. A WVAP line can be used as a scale to find the price where you should sell to minimize loss.
The above chart shows the price performance of HDFC bank along with the WVAP on a particular day. You can see that the price has crossed the VWAP line with a strong green candle.
Now, a reasonable price to set the stop-loss for is subjective, but the WVAP line can be of help. For instance, the price point where the VWAP value is crossed can be used as a point for stop-loss.
Importance of stock market awareness while using VWAP
If intraday trading was all about following the charts, anybody could have aced it. But it is much more complicated than that, and market awareness is critical when you do technical analysis. Take a look at the chart below.
Here, you can see that the price has crossed the WVAP line multiple times. What WVAP strategies tell you at these points is to buy the stock. But, as you can see, that could have resulted in a loss, and the price reverses every time.
Now, this is why market awareness is important. This chart is from a day when stock markets were on a bearish ride. A trader with that insight might stay away from trusting these WVAP indicators on this particular occasion. Hence, it is always wise to couple your technical analysis with common sense.
Read more: Basics of Stock Market
Using VWAP with other tools
A VWAP chart can give you better insights when coupled with other tools. As we have seen above, multiple factors could play a role in a stock’s price movement. Using another technical indicator can help you confirm a trend.
For instance, let us take the example of MACD. MACD is a momentum indicator. In a chart, a MACD line crossing over the signal line and moving up is an indicator to buy. At the same time, a movement downwards after the cross indicates a sell signal. Let us look at the above chart once more.
Here, pay attention to the area marked with a yellow arrow. You can see two strong red candles indicating a sell. But the next candle was green, and the price went up a bit. If you had followed VWAP alone, you could have made the wrong move.
But take a look at the MACD chart right below the two red candles. There is no indication to sell there, and the MACD line(blue line) and the signal line(red line) are pretty apart. If you had used MACD to confirm the trend here, you could avoid making the wrong move.
Tips for success using VWAP Indicator
To use VWAP successfully in your intraday trading, it is always advisable to use market awareness and similar technical indicators to confirm a trend. Theoretically, prices above the VWAP line indicate long positions, and prices below the VWAP line indicate short positions.
But as we have seen in the example with MACD above, VWAP can sometimes show false indications. Below are some tips that can help you apply VWAP in a practical situation.
Confirm before action – Always confirm the trend before making a move. You can use a trend confirming tool or look at the general stock market trend.
Wait for a strong signal – Make sure the price-VWAP crossover is strong. Two strong green or red candles usually denote a strong trend. Confirming so can help avoid miscalculations.
Use similar indicators – Couple your VWAP strategies with other indicators such as MACD, pivot points etc., for better results.
Apply caution – Understand that stock markets can act beyond anyone’s prediction. Therefore, always apply your strategies with caution.
How not to use VWAP Indicator?
Avoiding a few things can ensure you use VWAP to the fullest. This includes blindly following even the smallest of trend signals. Stock prices can stay volatile throughout the day, and they could cross or come close to crossing the VWAP line multiple times. But not all crosses denote a trend. Hence, it is advisable to ignore close shaves and weak crosses.
It is also essential to keep an eye on the volume of trades. Even when VWAP considers the volume traded, a small number of big trades can influence the VWAP line. Hence, it is wise to avoid VWAP indicators when the volume is low. Because of the same reason, VWAP might not give the most accurate data for small-cap companies as well.
Even when highly informational, VWAP has its share of limitations like any other technical indicator. Make sure you are mindful of these factors to get the best out of your trades.
As mentioned above, VWAP is limited to an intraday chart and stretching it over days can create distortion. Because of this, early trades could have a significant impact on the VWAP line. For instance, if there is an early day institutional buy or sell, it could affect VWAP’s efficiency. Experts suggest using VMAP after 10 am when the intraday charts have settled a bit to counter this.
Difference between VWAP & MVWAP
Moving volume-weighted average price or MVWAP is a similar indicator to VWAP, but there are some differences between them and their applications.
While VWAP starts fresh every day and gives the average value of stock throughout the day for better insights for intraday traders, MVWAP runs in the long term and is used by long-term trades. MVWAP does this by taking the average MVAP calculations.
Additionally, since VWAP resets every day, it could travel differently from the MVWAP line. This is especially true during the early market hours when the trading volume can be high.
Bottomline
Now that you have learned how VWAP works and are ready to apply it, keeping a few things in mind can help you avoid miscalculations and wrong moves.
To begin with, it is essential to understand that VWAP alone can’t predict stock markets. Markets, especially during intraday, can move for multiple reasons, some known, some unknown.
This is why stock markets remain a mystery even with analysis of over decades of stock market history. Hence, always make sure you stay on top of what is happening with the economy and use the technical indicators accordingly for the best results.
