VWAP or Volume Weighted Average Price is one of the most important day trading or intraday technical indicators , VWAP is the average price a stock or index has traded throughout the day , it’s importance is more in the sense that it not only incorporates the price but also the volume hence calculates the average using both volume and price.It is not only used by retail traders but also institutions for trading purpose hence it’s more important than a moving average or other lagging indicators .
How is Volume Weighted Average Price (VWAP) Calculated ?
The Basic Formula for VWAP is –
VWAP= ( ∑Price * Volume ) / ∑Volume
Hence we calculate the average price of the stock by adding the high , low and close price of the candle and substitute in the ∑Price , and that candlesticks volume in the volume field , in ∑Volume the cumulative volume for the whole period is put , here average keeps on accumulating hence for the first candle the VWAP will be the same as its average price , from the next candle onward the averages are added together that is ( ∑Price * Volume ) of previous candle is added to the next candle’s ( ∑Price * Volume ) and divided by the cumulative volume of both the candle hence giving the VWAP value for the second candle.
How to Trade using the VWAP ?
So now coming to the important use of this technical indicator , VWAP represents the volume centered average of a security so if a stock or index’s price moves above it’s VWAP what does it indicate ? It indicates the stock is trading above it’s average hence this indicate the strength in the stock vice versa is true when a stock moves below the VWAP , which indicates the weakness in the particular stock or index.
In general when a stock or index’s price moves above the VWAP it indicates that one should buy or go long , but this should not be used in isolation and should be paired with price action , candlestick patterns or support resistance levels etc , trading any technical indicator in isolation will not be much beneficial to any trader .
Above is the chart of Tech Mahindra as on NSE , it’s a 5 minute chart , the blue line is a resistance level which was well respected previously so when the stock broke above the resistance before it formed sort of bullish engulfing pattern and then rose higher and the stock was also above the VWAP hence it gave us the long bias and the reason to go long from that level indicating the strength in the stock and that the breakout might be real and not just a fake out (fake breakout).
Above is the same 5 minute chart of Tech Mahindra as on NSE , if you were to trade just because a stocks price moves above or below the VWAP you should look at the above chart again , see how the stock price whipsawed above and below the VWAP in the price range of just 2-3 Rs. which is not worthwhile to any trader , hence always use VWAP in combination with the Price action on technical chart , support/resistance , candlestick confirmations or any other technical indicator.
VWAP also acts as Support Resistance level –
VWAP has a tendency to act as dynamic support and resistance level , hence when a stock price moves above the VWAP and then takes support at the VWAP there one can take long trades , vice versa is true when a stock moves below the VWAP and VWAP then acts as resistance.
Above is the same 5 minute chart of Tech Mahindra as on NSE , look at the orange arrows where the stock took support at the VWAP and when the stock fell below the VWAP the VWAP then turned into a resistance level and followed the pure character stick of support resistance levels , here again we must not take this character stick of the VWAP being Support/Resistance on face value we must combine it with the candlestick patterns or stochastic / RSI , In the above chart you could have bought at the VWAP acting as support after confirmation from Stochastic indicator when the stochastic %K moved above the %D in the oversold region of stochastic.
Final Thoughts –
We have learned that VWAP is a very good and dependable indicator but like any other technical indicator it’s just an indicator , there can be nothing better than the plane old vanilla price action trading , indicators like VWAP are just made to make your decision easier and give you better discretion power , your whole strategy shouldn’t be based on a line of indicator moving up or down or price moving up and down a moving average , hence build your strategy likewise and use VWAP or any other indicator for just confirmation .