Technical indicators are an essential part of analyzing the financial markets. But what is the most fundamental indicator out there? Volume can be used as a tool for confirming a trend , identifying potential points of reversal, and many other strategies. The VWAP combines the power of volume with price action to create a practical and easy-to-use indicator. Traders may use the VWAP as a tool for trend confirmation, or as an instrument to identify entry and exit points.

How to Trade with the VWAP Indicator

VWAP stands for volume-weighted average price. What makes the VWAP a particularly powerful indicator is how it incorporates volume into the average price calculation. Some traders think that volume is the most important metric out there — outside of the price action itself.

What makes the VWAP an especially useful tool for both analysts and traders is how it combines these two important metrics into one indicator. The VWAP can give an indication of the dominant market trend, as well as important areas of liquidity. On most trading interfaces, you can just select the indicator, and the calculations will be done for you. Regardless, it could be helpful to know the formula behind it so you can use it more efficiently. So, how is the VWAP calculated? To calculate the VWAP, we need to add up the traded value for each transaction price multiplied by volume , then divide that by the total volume.

Now we understand why the VWAP is called a cumulative indicator , as the values are increasing by successive additions. For those interested in a more passive , longer-term investment style, the VWAP may be used as a benchmark for the current market outlook. With that said, some traders may use the price crossing the VWAP line as a signal to enter a trade.

If the price breaches and goes above the VWAP, they may get into a long position. Conversely, if the price breaches and goes below the VWAP, they may get into a short position. In this sense, the VWAP may be used similarly to moving averages.

What is the VWAP?

When the price is above the VWAP line, the market may be interpreted as bullish. This, of course, highly depends on the context of the technical pattern and should be taken with caution. The VWAP may also be used to identify areas of liquidity. This can be especially useful for institutional traders looking to fill large orders.

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Typically the VWAP is used by traders as a benchmark for whether or not they have paid too much for certain security or if they have gotten a bargain. For example, if the security purchased is higher than the VWAP line, the trader may have paid too much; if the security is purchased at a lower price than the VWAP line, the trader might have gotten a more optimal price. In practice, the VWAP might look like the moving average, but these two numbers are calculated in very, very different ways.

Calculating the Volume Weighted Average Price VWAP involves the price of the security multiplied by the number of securities traded divided by the total volume of securities. A moving average is calculated by adding up closing prices during a certain time frame then dividing that number by that time frame without any regard whatsoever to trading volume. Volume can be used as a metric for measuring the liquidity in the market for a certain security. This has a modulating effect on the price of the security, pushing it back towards its average.

VWAP indicator can be used in day trading as a trigger to enter into trade. The best performance VWAP in short-time trading gives as a filter of high volume trades. Usually, traders avoid trading short-time day trading trades when the volume is too large because their trades can be closed too early. Thus, the VWAP indicator helps day traders filter high volume trades and trade only during normal trading hours.

Day Trading Special: Volume Weighted Average Price

The biggest limitation to the VWAP is that it is a daily tracker. Extrapolating that information and mixing it with other VWAP numbers will give a trader little insight into security and may, in fact, vastly reshape the value of certain security for good or bad. Making decisions based upon this kind of erroneous information will not result in the optimal trades that the investor is seeking. Moving VWAP is used by traders making long-term purchases and is not useful for day traders or those who trade within very short intervals.

Because of its historical nature, VWAP is not useful for predicting future trends in isolation but must be used in concert with other metrics to make purchasing and selling decisions. What is Hull Moving Average?

What is the VWAP indicator? Author Recent Posts. Trader since Currently work for several prop trading companies. Latest posts by Fxigor see all.