In the fast-paced world of intraday trading, every tool at your disposal can make a significant difference in your success. One such tool that professional traders swear by is the Volume Weighted Average Price (VWAP). In this comprehensive guide, we will delve deep into how to use VWAP like a pro trader, complete with charts and images to illustrate its application. 

In this article, we’ll cover what VWAP is, and how you can trade it the right way. 

Note:

Personally, I use price action mostly for day-to-day trading. This article is to help you understand how to use VWAP more efficiently.

VWAP Explained

VWAP stands for Volume Weighted Average Price. It is a dynamic indicator that takes into account both price and trading volume. VWAP calculates the average price at which a security has traded throughout the trading day, weighted by the volume traded at each price level. This makes it a valuable tool for intraday traders seeking to understand the market's sentiment and make informed trading decisions. 

For example, if a portfolio manager needs to buy thousands of shares but also wants to pay less than the day’s average price, the VWAP is typically the price to beat.

The Importance of VWAP

Since it integrates both price and volume into its value, most analysts believe the VWAP is more reflective of the stock’s true average price. The VWAP estimate is independent of the stock’s closing price and has no direct impact on it.

Furthermore, since institutional traders use the VWAP as a reference for trading executions, the VWAP price level is regarded as highly influential in intraday price action.

Using the VWAP

Skilled and professional traders believe that Institutional traders use the VWAP as a point of reference. Traders also conclude that recognizing this dynamic must be incorporated into a trading strategy.

As a result, you might employ VWAP as a filter. This filter will be founded on the belief that buyers are more likely to build support when the price falls and touches to VWAP. (Check the below image for reference, the blue line is VWAP)

In comparison, you can prefer the opposite strategy. You’d think that buying a stock should only happen when the price is higher than the VWAP, and short-selling should only happen when the price is lower.

VWAP trading setup and examples

VWAP is an intraday market index that can be used to help traders determine whether to enter positions actively or passively. Many traders use the VWAP to help them buy at relatively low prices and sell at relatively higher prices.

VWAP has two simple setups: pullbacks and breakouts.

By far the most common setup for day traders looking for the best price is the VWAP pullback. Remember that day traders only have a few minutes to a few hours to complete a trade. 

1. VWAP Pullback

VWAP as a Key Support/Resistance Level:

• Long Trades: When the current market price is above VWAP and holds as support, it can be an entry signal for long trades. Traders often initiate buy positions in such cases, expecting upward momentum to continue.

• Short Trades: Conversely, when the market price is below VWAP and it acts as resistance, it can signal short trade opportunities. Traders may consider selling or shorting positions, anticipating a downward trend.

2. VWAP Breakout

This trading setup is intended for those who are unfamiliar with the VWAP indicator.

You must wait for an asset to test the VWAP to the downside. After that, you’ll want to wait for the asset to close above the VWAP.

Then, you’ll look to buy over the high of the candle that closed above the VWAP.

Advantages of using VWAP

 1) It assists traders in cutting through the noise generated by highs, lows, open, close, and other candle formations, and benchmarking the current price to the VWAP.

 2) Traders can quickly determine if quantities are being picked up (or sold) at low or high rates. He/she may deduce these details with a single glance.

 3) It enables traders to purchase or sell at the correct price (the VWAP) rather than entering a trade at current rates.

 4) VWAP, in particular, assists major traders such as institutions in trading at the best possible price.

Bottom line

When used in conjunction with market action or another technical trading technique, the VWAP indicator can help to ease the decision-making process. VWAP approaches must be combined with other price action studies to trade effectively.