Guide to VWAP Trading Strategy

What is the best time to get in and out of a trade? Traders worldwide seek the answer to this question and use various trading strategies to arrive at forecasts. A volume-weighted average price (VWAP) trading strategy uses changes in volume and stock prices to determine if an asset presents a buying or selling opportunity. Using the VWAP indicator alongside other information can help experienced investors make more informed trades, but it’s important to understand how VWAP works and how to calculate it. 

What Is VWAP?

VWAP uses stock price and volume movements to assess opportunities in the stock market. Some traders may also use candles with 1- or 5-minute intervals alongside VWAP to help predict how a stock’s price could move in the future.

For example, if a stock has a VWAP of $50, it means the stock has an average price of $50 per share throughout the designated time frame. Most investors use this technical analysis indicator in the morning and early afternoon when the market is more volatile. If this same stock is currently priced at $49.80, it is under the VWAP line and is considered bearish. 

How to Calculate VWAP?

To calculate VWAP, you need a candlestick. Candlesticks are visual representations of a stock’s price movement over a predetermined interval, usually for 1 or 5 minutes. The candlestick gives insight into a stock’s opening price, high, low and closing price for that interval. 

To calculate VWAP, you will need to know the high, low, and closing prices for a candle. After multiplying those numbers together, you divide by three to figure out the average stock price for that candlestick’s duration. Then you multiply this number by the volume to determine the total price volume for that candle. A trader must repeat this process for the following or prior candle. You calculate the total price volume for two consecutive candles and add them together. Finally, divide this sum by the combined volume of both candles.  

The math may sound complicated, but the formula and example below provide more clarity. You can run these numbers in an Excel document and have the math done automatically, but it’s good to know how the formulas work before punching numbers into a spreadsheet. Here is an example:

Candle 1: 

• High (H) = $45 
• Low (L) = $42 
• Closing Price (CP) = $43 
• Volume (V) = 45,000

Candle 2:

• High (H) = $44 
• Low (L) = $41 
• Closing Price (CP) = $42 
• Volume (V) = 48,000

VWAP = [(H1 + L1 + CP1) / 3 * V1 + (H2 + L2 + CP2) / 3 * V2] / [V1 + V2]  

VWAP = [(45 + 42 + 43) / 3 * 45,000 + (44 + 41 + 42) / 3 * 48,000] / [45,000 + 48,000]

VWAP = 130 / 3 * 45,000 + 127 / 3 * 48,000 / 93,000

VWAP = 43.33 * 45,000 + 42.33 * 48,000 / 93,000

VWAP =  (1,949,850 + 2,031,840) / 93,000

VWAP = 3,981,690 / 93,000 = $42.81

VWAP in this example is $42.81. Since the stock closed at $42 at the end of the candle, it is bearish according to the VWAP trading strategy. A trader may opt against starting a long position upon discovering this conclusion.

How to Apply VWAP Patterns in Your Trading Strategy

Now that you know how to calculate VWAP and the necessary inputs to put in an Excel spreadsheet, it’s time to consider how to incorporate stock chart patterns into your strategy. VWAP traders typically use this indicator for the following scenarios.

Pullbacks

VWAP traders don’t rush to make moves during the market’s opening minutes. Instead, these traders wait for candles to form so they can gauge if the stock price is moving above or below VWAP.  Some traders may consider buying a stock if its price exceeds VWAP and it may read a bearish signal if VWAP is greater than the stock’s current price.

Breakouts

Breakouts occur when a stock does the unexpected and breaks past a line of resistance or support. Buyers get stocks past lines of resistance while sellers push a stock below its line of support. If a stock is approaching the VWAP line from either direction, traders may wait for the stock to break out in either direction before starting a position. Breakouts can indicate that market sentiment is changing in the short term and may present a good opportunity for traders.

Support and Resistance

Stocks do not always break their support and resistance lines. Stocks may fail to break resistance lines because sellers overwhelm buyers at the last second, while buyers suddenly gain the upper hand to keep a stock above its support line. VWAP traders may look for stocks teetering at the line, and if they fail to break past the line, these traders may allocate funds assuming the stock will not break the line for the rest of the day.

Hold and Go Pattern

The hold and go pattern may apply with a stock with a significant news item or another development working in its favor. Under these conditions, the stock will be more volatile than usual at the open and can create an attractive entry point for a Hold and Go trader. 

VWAP and the stock should have a correlated, dramatic movement in either direction to start the day, but you can use VWAP after the initial momentum to help guide short-term trading decisions. Some day traders will wait for the stock to get closer to the VWAP line before adding to their positions, believing a breakout will not happen.  

Fade to VWAP

A stock may reach its high for the day before encountering resistance. Some VWAP traders may start short positions when stocks have seemingly overstretched themselves and seek to exit positions once those stock prices get closer to VWAP. It can be easier to find a fade to VWAP if the stock has challenged this resistance or support line multiple times but still fails to break through.

Market Trends

VWAP can help provide a clearer picture of where the market trends may be heading and how you want to proceed. . VWAP can help provide insights on whether buyers or sellers are in control. If a stock is priced below its VWAP but soon passes it, the stock may present an attractive trading opportunity. A stock higher than its VWAP can become a bearish pick if it proceeds to fall below VWAP.

How to Find VWAP Trades

Traders should start with stocks they know and expand their horizons as they get more experience. Every stock has a VWAP, and advanced investors may find buying and selling opportunities based on stock price fluctuations and the difference between the market price and VWAP. Some stock brokers have VWAP compatibility, which makes it easier to spot opportunities based on your criteria.

Significance of VWAP

VWAP gives you a snapshot of the battle between buyers and sellers. This indicator demonstrates trends in action and can help you determine if the market is bullish or bearish. You can go on a macro level with VWAPs for index funds or follow this process for individual stocks. 

Limitations of VWAP

Although VWAP can help traders determine market sentiment at the moment, it is a lagging indicator. VWAP traders may get caught by surprise because of a quick and sudden reversal since they make educated guesses based on past candles. VWAP also isn’t the best indicator to identify long term trends as it's typically used as a one-day indicator since it resets at the start of each trading day. 

VWAP vs. Moving VWAP (MVWAP)

MVWAP is an extended version of VWAP. MVWAP takes multiple VWAP calculations across a wider time frame. You can get an MVWAP that takes days, weeks and months into account. A calculation like the MVWAP smooths out sharp volatility and can paint a long-term picture. VWAP has a definitive start and end and cannot stretch into a new day. This dynamic results in VWAP having a stronger response to short-term volatility.

Using VWAP Within Your Trading Strategy

VWAP is a useful metric that helps traders assess whether a stock may be bullish or bearish at the moment. While using the VWAP trading strategy isn’t optimal for use with longer time periods, it can provide valuable insights for a trader who is looking for a clearer picture of where the market momentum may be heading and identifying potential opportunities.

Frequently Asked Questions