Click to learn how to use the VWAP (Volume Weighted Average Price) technical indicator for successful trading. VWAP primarily highlights the average price of specific assets, but it also incorporates the asset’s volume to provide a comprehensive view of market sentiment and price direction.
Before the emergence of technical analysis and Dow Theory, stock trading focused more on interpreting economic data, monitoring company performance, and analyzing market price trends, rather than relying on numerical trading charts or technical indicators. Although today’s trading practices differ, the fundamentals of trading remain the same.
To achieve profitable trades, traders need to understand the market and easily identify market trends. Nowadays, the use of technical indicators makes the trading process simpler, as these indicators highlight key points in price and volume, signaling potential profit opportunities for individual trades. The Volume Weighted Average Price (VWAP) indicator is one such tool.
The history of the VWAP indicator
In the 1980s, Kyle Krehbiel introduced the VWAP indicator to the trading field to help traders determine the market value of an asset using price and volume. Since then, the VWAP indicator has gradually gained attention, with subsequent variations (such as anchored VWAP) providing further insights into market dynamics.
What is the VWAP indicator?
VWAP (Volume Weighted Average Price) is a technical analysis indicator that provides insight into the price trends and true value of cryptocurrencies. VWAP considers two main factors: cumulative volume and cumulative typical price.
Like other average price indicators, VWAP primarily highlights the average price of specific assets, but it also combines the asset's volume to provide a comprehensive view of market sentiment and price direction.
How to calculate the VWAP indicator
Like most indicators, VWAP is typically built into computerized trading charts. However, understanding its calculation is very helpful if the trading chart does not provide the calculation method for the indicator.
VWAP is typically calculated per trading day, from market open to close, with all calculated values based on that day's trading chart.
Calculating VWAP requires three values:
Cumulative typical price: The average price for the trading period. Add the high, low, and close prices together and divide by 3 to get this price, with the formula: "(H+L+C)/3."
Volume: The total volume for the time period.
Cumulative volume: The total volume within the trading day.
With these three values, you can calculate VWAP, the formula is as follows:
With the formula, you can calculate VWAP by following these steps:
Find the average price of the coin for the first 15 minutes of the day, then add the high, low, and close prices and divide by 3.
Multiply the average price by the volume for the same period, and record the final result in notes or a spreadsheet.
Use the above formula to divide the total PV (price multiplied by volume) by the trading volume for that time period to obtain the weighted average price (VWAP).
Note: To maintain VWAP throughout a day, each period's PV value must continually be added to the total and then divided by the cumulative trading volume of the period.
If you use a table to track each cumulative PV value and cumulative trading volume, manually calculating VWAP becomes simpler.
The use of the VWAP indicator
Like other technical indicators, the VWAP line is helpful in identifying specific market trends. By analyzing the position of the VWAP line relative to price points, traders can determine whether the asset's price trend is bearish or bullish.
Typically, when an asset's price is above the VWAP line, it indicates that the trading price is higher than the volume weighted average price, suggesting an upward trend.
When the opposite occurs, i.e., the price falls below the average, it is a signal for asset decline, indicating that the current selling price of the asset is below its average level.
The VWAP line can help traders identify overbought and oversold conditions in the market, thereby assisting them in making more informed trading decisions. When the price is above the VWAP line, it indicates that the asset may be overbought; conversely, if the price is below the VWAP line, it suggests that the asset is oversold. With these signals and market conditions, traders can engage in predictive trading to avoid losses from future corrective trends.
The VWAP line can also serve as a support or resistance level. By analyzing the movement of the VWAP line, traders can assess the strength of the current price trend and the likelihood of a reversal. When the price approaches the VWAP line from below, it is viewed as a support level; conversely, it is viewed as a resistance level when approached from above.
How to trade using the VWAP indicator?
Even with a reliable technical indicator like the VWAP, there is no guarantee of a one-size-fits-all successful trading strategy. The cryptocurrency market is unique, often exhibiting price instability and high volatility, making unique trading strategies necessary, typically combining technical indicators with strong trading strategies. Here are some best trading strategies that combine the VWAP indicator with other tools:
VWAP Bands and Channels
The VWAP indicator includes upper and lower bands, which can be used to identify buy and sell signals. When the price rebounds within the channel (between the upper and lower bands), a buy signal occurs. If the price breaks above the upper band, it is typically considered overbought; conversely, if the price falls below the lower band, it is considered oversold.
Traders can rely on the VWAP indicator's bands and channels to identify potential profitable trading opportunities and make well-informed decisions about when to buy or sell orders.
Breakout trading strategy
In trading strategies, a breakout refers to an asset breaking through support or resistance levels accompanied by an increase in volume. This strategy utilizes early changes in market trends, helping traders capture early price trends and execute profitable trades.
As mentioned earlier, the VWAP indicator can serve as a resistance level. When the VWAP line crosses the price, it may signal an upward trend in the asset's price. Therefore, traders using breakout strategies can utilize the VWAP line as a support or resistance level to determine suitable buy or sell order points based on market changes.
Retracement and reversal trading
Retracement trading identifies temporary price reversal situations through analysis of asset price charts and enters the market during brief price pullback trends. Traders adopting retracement trading can use the VWAP indicator to identify temporary pullbacks in price trends, allowing for trades at appropriate times.
Should the VWAP indicator be used in conjunction with other technical indicators?
Although the VWAP indicator is very useful in understanding market trends and price averages, it is not recommended to rely solely on it as the entirety of a trading strategy. The VWAP indicator can show how the asset price compares to its average, but it does not take into account the strength of price trends, the volatility of the asset, or market sentiment and momentum. Therefore, combining VWAP with other technical indicators can provide more favorable strategies.
Different indicators provide unique perspectives; some track momentum while others assess trend reversals or price volatility. The following three indicators can complement VWAP and enhance its effectiveness in cryptocurrency trading:
Relative Strength Index (RSI)
RSI measures the momentum of price movements, helping to identify whether cryptocurrencies are overbought or oversold. When used with VWAP, RSI can assist traders in confirming market conditions. For example, if the coin price is above the VWAP line, indicating an upward trend, but RSI shows overbought levels, it suggests that the price may pull back or adjust. This combination of indicators allows traders to verify trends while being aware of potential reversal signals.
Moving Average Convergence Divergence (MACD)
MACD is a popular trend-following indicator that reveals momentum changes. When used in conjunction with VWAP, MACD helps to confirm the strength of trends. If the price is above VWAP and MACD shows a bullish crossover (i.e., the MACD line crosses above the signal line), it indicates that upward trend momentum is strengthening. Conversely, if the price is below VWAP and MACD shows a bearish crossover, it suggests that the downward trend may continue. MACD can indicate momentum shifts, making it an effective tool to assist VWAP, helping traders to seize buying and selling opportunities.
Bollinger Bands
Bollinger Bands measure market volatility and identify potential breakout or pullback opportunities. When used in conjunction with VWAP, they help to confirm whether price trends are sustainable or temporary. If the price breaks above VWAP and exceeds the upper Bollinger Band, it indicates a potential breakout signal. Conversely, if the price is within the Bollinger Band range but approaches the VWAP line, it may suggest market stability or a potential pullback. The combination of VWAP and Bollinger Bands allows traders to assess both price levels and market volatility, enhancing their ability to predict trend reversals.
Conclusion
The Weighted Average Price (VWAP) indicator is very helpful and can provide traders with insights into market trends and price averages. By understanding how VWAP is calculated and interpreting it, traders can make more informed buying and selling decisions in cryptocurrencies. Although the VWAP tool is powerful, it is recommended to use it in conjunction with other indicators to provide a more comprehensive market perspective and make trading strategies more effective.
