The problem with chart analysis is it’s subjective.
Definitely more art than science.
But it’s not all bad.
If we all had the same opinions then there wouldn’t be any volatility in the market.
But as a technical trader I can tell you that not all indicators are created equal.
Some of them are just a complete waste of time.
And in the long-run end up costing you a lot of money.
Good news though…
I researched endlessly until I found what works— so you don’t have to!
Today I’m going to teach you about an indicator that flat out works.
It takes into account how much buyers and sellers actually trade.
It’s called the Volume Weighted Average Price, or better known as, the VWAP.
Mastering it will help you improve your entries and exits.
And most importantly, allow you to squeeze more profits out of trades.
I’m excited to teach you this.
Calculating the average price based on closes will not provide an accurate representation of a stocks trading history.
This is where the Volume Weighted Average Price is needed.
So what is Volume Weighted Average Price or VWAP anyways?
VWAP is the true average price of a stock by factoring the volume of the trades at a specific price instead of the closing price.
Unlike the 50sma which is the average of 50 bars, the VWAP is an indicator that actually reacts to the price moved based on volume.
In this article, we are going to dig into the different ways you can trade and analyze price action using VWAP.
VWAP – The Setup
After analyzing the VWAP on thousands of charts, there are two distinct patterns that become apparent. These are the pullack and the breakout.
Since day traders only have a few critical minutes to make a trading decision, it’s imperative they master these two patterns.
Now…let’s take a look at each one of these setups.
VWAP Setup – Breakout Momentum
This is one of the more aggressive setups for a VWAP trader.
The breakout is defined by the price moving from one side of vwap to the other.
By waiting for the breakout and confirming it with price action, you can get some of the most powerful signals at this point.
The signal was when the stock changed character and went from being weak when it was trading under the VWAP to being strong when it broke out and stayed above vwap.
This change in behavior of the stock is what makes the signal so reliable.
Trade Type: Aggressive
VWAP Setup – Pullback Momentum
A passive way to trade momentum VWAP is with the Pullback setup pattern.
In this pattern you are looking for the price to show positive momentum to the upside earlier in the day .
Once the stock has shown to be strong in the morning, you would look for VWAP to draw the price back in before heading higher again in the original direction.
Here’s an example of a pullback momentum strategy.
Trade Type: Semi-Aggressive – Novice Level
VWAP Setup – VWAP Targets
Sometimes I miss my entry… that’s part of trading after all. And as a good, disciplined trader, I sit on my hands and force myself to not chase the trade.
But that does not mean I do not want to trade it at all just to sit there and watch it from the sidelines.
Now suppose that you missed your breakout trade and the SPY’s moved higher without you.
So, what do you do? Well, you look for a point where you can trade a reversal back to VWAP…
Think of it as a counter signal to the original move that lets you trade a stock without chasing the price higher.
And that is where the VWAP Target strategy is used.
VWAP Target Strategy
In order to sell the stocks back to the VWAP (or target) you need a way to find when they are over extended and then are likely to revert.
One way to find areas of mean reversion is to use a Bollinger Band concept on the VWAP price and buy or sell when the price exceeds those bands.
Here is an example of this strategy on the SPY’s as the price continuously traded above the 2 standard deviation bands and reverted to the VWAP price shortly afterwards.
The Target VWAP steps:
- After initial momentum move higher (or lower), look for price to trade outside of 2 standard deviation of upper(lower) VWAP (in red)
- Look to go short at or above upper 2 standard deviation VWAP’s (for long, use lower 2 standard deviation VWAP)
- Target the VWAP as the exit price for the trade
Trade Type: Extremely Aggressive – Expert Level
For many traders, VWAP is going to sound like a foreign language when they are used to talking about moving averages and Bollinger Bands,
But VWAP is actually quite similar to what they are already used to using every day.
And with practice, it will actually generate better quality trading setups compared with a moving average strategy.
And with a little practice VWAP will become your go-to indicator in your toolbox – just like it has for me!