What is the Volume Weighted Average Price or VWAP, and how does it factor into your calculations as a trader?
First, the Volume Weighted Average Price is a purely day-trading phenomenon, but it can be used in various chart time frames.
What is the Vwap indicator? Volume Weighted Average Price, or VWAP is a famous trading indicator that uses the average price of a certain security product as tracked throughout a trading period of one day calculated using both the number of products traded or the volume, as well as the prices those products traded for on the exchange.
How to calculate vwap?
VWAP formula is :
VWAP=(?Price * Volume?)/?Volume
How to calculate Vwap in Excel?
In this video, you can see how you can calculate VWAP in Excel easily using the formula above:
How to Download VWAP and how to set up VWAP?
If you use Metatrader, there are free VWAP indicator to download. IF you are using other platforms, use the VWAP indicator from tradingview platform.
Volume Weighted Average Price VWAP indicator and NIFTY trading
How day traders use this is a metric for forecasting trends in the security’s value and determining any hidden value revealed by the trading activity, such as the security’s use in arbitrage and the like.
On financial charts, the Volume Weighted Average Price is denoted by a single line on intraday activity and shows movement in 1 minute, 5 minutes, 15-minute increments, and so on. How traders interpret this line is varied. Still, typically, a VWAP that is going up or above the VWAP line indicates that the security price will also move in an upward direction.
The NIFTY 50 index (futures or other) is the National Stock Exchange of India’s benchmark broad based famous stock market index for the Indian equity market. A lot of traders like to use VWAP for indexes and, therefore, NYFTY.
Trading strategy :
The VWAP indicator is based on the moving average. In the trend trading market, if the price is above VWAP, we can suggest that the price will continue to go bullish and if it is below, to go bearish. Of course, this way of trading is too simple, and VWAP can not predict the market.
However, in combination with VWAP bands and important levels, we can see a better way of trading :
Important levels and VWAP can give us better direction :
Conversely, a VWAP line that falls below the VWAP typically indicates security with a falling price.
One can readily see how this information would be critical for day traders, particularly those making money through arbitrage.
The only real downside to the VWAP is that it is historical and predictive or current analysis. Traders have to use the VWAP in tandem with other security information to determine current pricing and predict future pricing.
Volume Weighted Average Price VWAP strategy for NIFTY trading.
In our prop company, we use the linear regression equation to calculate Target and Stop Loss based on the Average True Range. In this example, we will put Daily ATR as target and stop-loss, but you need to set your own stop loss and target level in real trading conditions.
We created a strategy :
BUY, if important Fib. The level is touched, AND the price is above the VWAP line, AND the RSI index trend line is bullish. Stop loss is the last swing. Target is 1 Daily ATR.
SELL if important Fib. The level is touched, AND the price is below the VWAP line, AND the RSI index trend line is bearish. Stop loss is the last swing. Target is 1 Daily ATR.
We wrote an article about RSI and how to draw trend lines on the RSI indicator.
VWAP strategy Discussion
In our strategy, we use the strategy with a 1 to 1 risk-reward ratio on average. We had 62% profitable trades for the last 10 years. The most important criteria were the RSI trend line, which was drawn manually on the chart, and the VWAP indicator.
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.
As we described above, the VWAP has a variety of uses depending on the trader or institution.
For example, large institutional investors like mutual funds use the VWAP as a way to determine when to enter and exit the market for particular security with as minimal disruption to that security’s price as possible. This has a modulating effect on the price of the security, pushing it back towards its average. When the price is below the VWAP, these funds will purchase it; when it is slightly above, they will sell it, all while impacting the security’s moving price minimally.
On the end
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 found by adding closing VWAP figures and averaging them over several periods. 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.