Volume-Weighted Average Price or VWAP is a technical indicator used by traders to detect support and resistance levels, manage trade entries / exits, determine market direction, measure trend strength and more.
How is VWAP Calculated?
Price and volume are keystones of order flow data – price being the end result of buying and selling volume. Price movement depends on whether buyers or sellers were more aggressive during a trading session. The significance of a price move often correlates to the amount of volume traded during the action.
Volume-Weighted Average price is similar to a moving average but volume data is incorporated to “weigh” the average price over a specified time period. The basic formula used is:
In other words, Volume-Weighted Average Price (VWAP) takes the total dollar amount transacted and divides that number by the total number of units traded.
VWAP Standard Deviation Bands
In addition to the VWAP itself, which plots as a single line, standard deviation lines are often used to help indicate potential support & resistance and other key price levels. Also based on mathematical calculations, common multipliers used for VWAP standard deviations are 1, 2 and 3.
In the chart above, one day of Micro E-mini Dow futures trading is shown on a 15-minute timeframe. The VWAP line alternates between green and red if price is above or below the VWAP, respectively. 3 standard deviation bands can be seen above and below the VWAP line. As you can see, price tends to react when it comes into contact with the VWAP.
Why Do Day Traders Use VWAP in Their Trading Strategy?
As compared to a traditional moving average, VWAP identifies a “true” average price by factoring in the volume of transactions at each price level. There are several reasons order flow traders incorporate VWAP into their analysis approach:
- Identifying support & resistance levels
- Tracking price reversals
- Confirming or denying trends
- Determining the strength of a market
- Fine-tuning trade entries & exits
Using VWAP for Institutional Perspective
In addition to the uses above, order flow traders reference VWAP to get an idea of where institutional traders are initiating and liquidating positions. VWAP is commonly used by institutions such as hedge and pension funds when building and closing positions. Considered a benchmark for order fills, institutional VWAP traders seek to buy below the VWAP line and sell above it.
As with other indicators, VWAP has the potential to produce false signals and should be used in combination with other analysis tools to confirm a trade thesis. As always, risk management should remain paramount for investors.
Get Started with Order Flow +
VWAP is included with NinjaTrader’s Order Flow + suite of premium technical analysis tools. It features customizable standard deviation bands and can be used on daily, weekly and monthly timeframes.
Current NinjaTrader users can get started with Volume Profile and the rest of the Order Flow + suite today: Learn More.
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