First off, what is VWAP? VWAP stands for volume-weighted average price. The VWAP calculates where a stock’s price should be based on its highs, lows, volume, and price duration. The VWAP then shows as a line on the chart which represents its estimated volume weighted average price, based on those four variables.
VWAP on a chart
Looking at Figure 1, a 2D/15MIN $SPY chart, there is a white line trailing the candlesticks, that is the VWAP. Each day the VWAP resets at 4 AM and displays its new trail based on the intra-day volume and price action that followed the pre-market and open. The day trader can also include pre-market VWAP calculations at their discretion, but some traders prefer not to enable it until after market opens. Since VWAP is an intra-day indicator, traders are looking to apply it to smaller scaler trends instead of larger.SPY 2D/15MIN. Figure 1 (ZeroPro: June 28,2022)
Applying VWAP as a day-trader
When should a trader use VWAP? The VWAP does not, and never will tell a trader when to buy or when to sell. The VWAP is only there to assist a trader in their decision making. Now that it is understood that this is a tool to assist a trader in their efforts, it is time to try to apply it to a chart to understand a couple scenarios in which using the VWAP can be helpful.
SPY 2D/15MIN. Figure 1 (ZeroPro: June 28,2022)
Using Figure 1 for reference again. At 9:30AM the $SPY is trading at roughly $391. A day trader opens their laptop and has the VWAP applied to ZeroPro as shown. Say, for example, there are long-biased day traders interested in buying the $SPY in the morning and selling it later in the day at a higher price. This trader may decide to avoid the morning trade if they choose to see VWAP as resistance. Once the stock rejects from the VWAP indicator and fails it may be perceived as weakness and not a long day trade.
A short biased trader may be looking to short the $SPY and buy it back at a later price. When the market opens at 9:30 AM, the trader notices that the price is trading on par with the VWAP. They decide to wait until the price is above or equal to VWAP and short the stock if it rejects the VWAP as resistance.
Both scenarios are to understand how VWAP can be perceived in real time alongside a trading plan. Trading based solely from VWAP is not usually a recommended strategy and is only generally used as an indicator to assist a trader in their plan.
VWAP is a tool, just like a watchlist, a scanner and the level 2 tape. It must be used with a grain of salt and a solid trading plan. It won’t ever tell a trader what the stock is going to do next, but it can assist them in making their decision.
A few key-takeaways:
- VWAP is only an indicator to help a trader, not a buy or sell signal
- VWAP resets intra-day and is better used for short-term forecasting
- Use a clean charting system that allows you to customize your indicators and watchlists, such as ZeroPro
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