The importance of VWAP
As previously mentioned VWAP shows where the volume is and at which price; it is displayed in a line on the day traders’ chart. Now combine price action with the VWAP indicator, and a day trader can spot the relations between these two factors. If the current price of a stock is under VWAP we speak of the stock as ‘undervalued’, and when the price is above VWAP the stock can be seen as ‘overvalued’. A day trader needs to be aware of the timeframe that they are trading on; what can be seen as undervalued on the 5-minute chart could be overvalued on the 15-minute chart. Therefore, it is crucial to understand the timeframe a day trader uses VWAP to make trading decisions. Sometimes, when the stock is well above VWAP it can be seen as a good short opportunity as the price is beginning to get too overextended and needs to eventually come back down. Stocks generally move in waves up or down and usually do not go straight up or down most of the time. The same can be applied to when the price is well below VWAP for long opportunities; when the price is too undervalued, it will eventually stabilize, find support and move back up. This is not an exact science though, and can be used as a way to help traders make better trading decisions by seeing the relation between price action and the VWAP indicator. Knowing the theory of how VWAP works is one thing but seeing it visually is what really matters.
VWAP chart examples
Here we have a 5-minute chart of $KZR from June 28, 2022; the stock has gapped up after hours and is well up over +90% at 9:30 am EST. The stock is hugging VWAP at the market open, touching it briefly and from there on we reject and continue to sell off the entire day. In this case, VWAP acted as a strong resistance from the market open where the force of sellers was too strong to take this stock higher. Now, this is where day traders should remember that ‘trading not being an exact science’, see the stock was under VWAP the entire day (undervalued) but keep in mind we have had a gap up well over +90%. In this case, the stock showed that it had exhausted itself too early to keep going; VWAP acted as a strong resistance. The more we deviated to the downside, the more ‘broken’ the stock became (broken meaning rejection after rejection).
Up next is $SRG on the 3-minute chart, which gapped up +50% on news. The stock opened under VWAP and briefly rose above it in the first 15 minutes of the day before falling back to support. The stock consolidated for a period and then took out these resistance levels to continue higher. In this case, when the stock was below VWAP (undervalued), it proved to be a good opportunity for a long position since the stock went up all day from here. It can also be seen that around mid-day, the stock started to pull back towards the $10.00 zone, which was in fact, close to that 9.80’s VWAP line. Even though price did not reach VWAP on the spot, the zone held and acted as a support level where the price bounced off to make higher highs. VWAP could have helped a day trader spot the stock as undervalued and capitalize on the long opportunity.
Here is a 1-minute chart of $GOEV, which is gapping up around +95% at market open. From the open, the stock has extended a lot from VWAP, which signals that the stock is quite overvalued. After market open, the stock looks to be selling off in the first minute, only to go up higher and eventually top out at $5.00. Since the stock is so far above VWAP shorting is potentially more interesting, the buying volume drops at around 9:41, and the stock fails to break that key $5.00 level (psychological number acting as resistance). Quite soon after this, the stock starts to deep dive and sell off fast all the way back to $4.00. Now a day trader had to be quick on that first move, but after the stock went under VWAP we saw that VWAP ended up as a good level of resistance during that 10:20-10:40 time period. The stock tested VWAP a few more times before fading off after 12:30 and continuing to fade the entire day. In this case, VWAP proved to be yet again a beneficial tool in assessing potential trade opportunities.
In the end, VWAP is simply one indicator that could help a day trader make better decisions when trading. The VWAP indicator could help you gauge the price action better when a stock is overvalued, undervalued, broken or strong; it is a vital tool to have in the day trader’s arsenal. Trading is all about collecting the right pieces of the puzzle to try to trade with the odds in the trader’s favor, and VWAP is a great tool to help the day trader do that.
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