A fast-paced day trader is interested in making profits quickly as they happen, but because price does not always provide enough information for traders to determine the price's fair value, volume is often used. Therefore, the VWAP Indicator (Volume Weighted Average Price) has become increasingly useful to day traders.
The VWAP is often referred to as the "Holy Grail" of day trading because it creates a benchmark for institutional buying and selling of stocks. An understanding of VWAP can enhance Successful Intraday Trading Strategies for Beginners or an experienced professional trader.
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What is the VWAP Indicator?
VWAP stands for Volume Weighted Average Price; however, unlike a standard moving average, VWAP takes into account how many total shares of a stock were bought and sold at various price points. Because VWAP reflects volume as well as price, it is a more accurate representation of the "equilibrium" price for the day. A trader who buys below the VWAP is receiving a better-than-average price for the day, and therefore, it is one of the top technical analysis tools every trader should utilize because it helps filter out market noise and volatility.
VWAP vs. Moving Averages: What’s the Difference?
Although the VWAP (Volume Weighted Average Price) and the SMA (Simple Moving Average) or EMA (Exponential Moving Average) may look quite alike on a chart, their purposes are vastly different.
The VWAP indicator takes into account price movement weighted by volume, with higher volumes given greater weight in the calculation, whereas SMAs and EMAs only take into account price movements over a set period of time.
Whereas moving averages are extended into subsequent days and therefore maintain a continuous, ongoing trend for that asset, the VWAP resets on a daily basis at the beginning of each trading session, inherently making the VWAP a much clearer representation of the true price trend.
In addition, large institutional investors typically use the VWAP indicator as a guide for executing their orders. By executing their larger buy orders around the VWAP and executing their larger sell orders above the VWAP, these traders are able to execute large orders without skewing the price of the asset negatively.
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How to Read the VWAP Indicator?
Understanding VWAP is easy; one must possess an understanding of market sentiment to successfully apply the VWAP indicator.
When a stock's current price is greater than the VWAP, the market is said to be in a bullish condition, with the buyers controlling the price movement. Therefore, all average market participants (buyers and sellers) are making profits.
Conversely, when the current stock price is less than the VWAP, the market is said to be in a bearish condition, with sellers controlling the price movement. Therefore, all average market participants (buyers and sellers) are experiencing losses.
Support & Resistance: The VWAP (Volume Weighted Average Price) usually provides support and/or resistance. When traders learn how to use support and resistance when trading stocks, they will monitor the VWAP line for price to "bounce" off the VWAP line prior to making an entry into a trade.
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Top 3 Intraday Strategies Using VWAP
If you want to learn how to make 5000 rs daily in the stock market, it's best to have a structured plan of action. The three most popular VWAP trading strategies are:
The VWAP Pullback Strategy
When a stock is trending to the upside, prices do NOT move in a linear fashion. In fact, they will "pull back" to the average price level (VWAP). Traders will look for opportunities to enter a trade when the price pulls back down to the VWAP line, keeps touching it, and eventually signifies a bullish candlestick pattern forming at that point. This would be considered a very high probability entry point.
The VWAP Breakout Strategy
For this strategy, simply wait until you observe that a stock is consolidating right below the VWAP line, and then look for a breakout where the price of the stock finally peaks above the VWAP line, accompanied by a large increase in volume. This is an indication that "smart money" has begun to enter into that particular stock. It is common for this strategy to be paired with using the MACD indicator for additional confirmation before making your entry into that trade.
Mean Reversion using Standard Deviation
When traders visualize the VWAP using Bands, they do so much like Bollinger Bands, with price action moving away from VWAP by a certain standard deviation. The further the price moves beyond the VWAP (+ or - 2 SD), the more "overextended" they believe it is (and therefore likely to return toward the VWAP).
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Limitations of VWAP
While the VWAP can be an extremely useful indicator, it has its limitations.
Short-Term Only: The VWAP is designed for intraday trading/investing, and therefore, if your focus is on longer time frames, you may want to consider Swing Trading instead.
Lagging Indicator: As the day goes on, the VWAP gathers a lot of data points and becomes a "lagging indicator". In order for the VWAP line to change directions, there needs to be a big enough price move at 3 PM.
Doubling Up Doesn't Mean You Are Ahead: Relying on a single indicator is risky, so always practice risk management when trading to safeguard your investment dollars.
Conclusion
For those who are serious about intraday trading, the VWAP Indicator should be a must-have in your trading toolbox. Since it provides a phenotype of the results of the battle between the bull and the bear by using both volume and price together, it is a very good indicator of who is currently winning that fight. Keep in mind that, as with all indicators, none can ever be 100% accurate, and successful traders often will combine the use of VWAP with other indicators such as open interest analysis and proper chart patterns.
If you're ready to elevate your trading game, consider investigating algorithmic trading and how indicators like VWAP are integrated into these systems!
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