Greetings traders and welcome back to another Survival Guide.
Chris here, as always, bringing you some more information. In
today's discussion, we'll be covering the VWAP.
This is known as the Volume Weighted Average Price.
It is an indicator, so those of you that like the technical analysis based discussions
that we have, well you're in for a treat.
This is something that, when understood and mastered correctly,
can be exactly what you need to pass the Gauntlet Mini. It
provides an in-depth view of what's going on in the market and
can give you some insights that may not be visible when you're
just looking at playing charts in comparison.
But before we go any further, let's talk about how we can
apply the VWAP to the charts.
That way you can follow along during the entire discussion.
If we're using the Finamark platform,
we're simply going to go to the top center portion of the
screen, where we're going to click on the "show indicator options" button.
Now, because the VWAP does overlay the candlesticks
themselves, it will be in the center icon
here, or the center column I should say. As we scroll
down, you'll see VWAP down here, second to bottom. If we give
that a click, it will apply it to the charts,
and when we returned to the charts, we will see that there
is now a line running through price.
That is our VWAP. Now, without any further ado,
let's go ahead and get started so we can learn more about the VWAP.
A rather large mistake that traders sometimes make in the
beginning of their trading career is analyzing an instrument's
average price based only on its closing value. But for traders
and long-term investors who want to get a more clear picture
of the health of whatever it is that they are analyzing, they
became aware that there's a lot more to it than that and
that's why they began looking for a tool that would allow
them to help identify a traded instrument's actual average price
by taking trading volume into account. Hence, the Volume Weighted Average Price
was born. This is considered to be one of
the best instruments for a fair representation of the traded instrument's quality.
Let's talk about exactly what the Volume Weighted Average Price is
otherwise known as the VWAP.
Well, as we saw, it is a trading indicator that we can apply
to our charts, but this indicator considers both volume and
pricing information to come up with a complete representation
of the average price a security has traded at throughout
the entire training session that is being measured. The Volume
Weighted Average Price serves as a benchmark for market participants
looking to get a clear and detailed picture of particular investments
that they're looking to make, or a trading opportunity that
they're looking to become involved with. The VWAP stands
out because it reflects the stock's real average price based
on the volume of transactions instead of just the closing
numbers. The VWAP is also essential because it gives the
market participants insights about the trend and the value
of the traded security that they're analyzing. Due to all of this,
it has become a very prevalent tool for everyone involved
in buying and selling financial
instruments today, and it's quite commonly used. Today,
day traders, speculators, and large-scale investors, like pension
funds and mutual funds, all are known to use the VWAP
from time to time. On a chart, the VWAP is usually
displayed as a moving average but is much slower than a typical
8 or 20-period moving average.
The calculation for the VWAP is relatively simple. The
VWAP is equal to price times volume over volume.
There is another, more academic version of this equation that
you can find online if you so choose, but we're not going
to cover it here because I feel it just unnecessarily makes
it look scarier and more complicated, and ultimately, we won't
really ever have to actually do this math.
This is just being displayed
so we have an idea of where these values are coming from
because after all, in the end, both of the formulas that are used
to calculate the VWAP
do the same exact thing. They take the number of shares bought
and multiply it by the share price.
Then, the number is divided by the total shares bought. The
result is the value for the
VWAP. It represents the asset's average price based on the
number of shares or whatever
it is that we are measuring, maybe it's contracts, if it's
shares, if we're talking about socks;
It measures it traded at different prices throughout the trading session.
The timeframe the calculation is made for is usually a
single day or what we can consider a period. Nowadays, traders rarely, if ever,
just calculate it by hand
so once again, don't stress the math so much.
This is just, once again, to keep you in the loop with where
these numbers are actually coming from.
How can the VWAP help us as traders?
Well, the short answer is by giving us a more accurate representation
of the traded instrument's actual price. Market participants
who consider only the instrument's closing price usually fail
to acknowledge the role that volume plays in the process.
As a result, they may fail to realize the effect that this has on the
general trend. For example, did the stock hit a new low with
low trading volume? Or did it close at a high with low volume?
The additional context the VWAP provides allows the trader
to make more informed decisions and better project the strength
of the traded instrument's trend and health. Day traders and
speculators use the VWAP to evaluate how good the momentum
is for buying and selling. They generally will build strategies
around the VWAP and often employ it as a confirmation tool,
but mostly for trades that last from a few minutes to no
more than a couple hours. The most popular scenario is going
long when the price range is above the
VWAP, and going short when it is ranging below it.
Day traders also have a rule of thumb that protects their
positions from whipsaw effects in price.
This rule usually is around the concept that if the
VWAP line is flat but price has made a quick up or down move,
the most likely scenario will revert to the VWAP line, meaning
price will be likely to revert to the VWAP line. On the
other hand, if the VWAP line is getting steeper, along with
the trend, counter-trend positions usually aren't advisable
in this scenario. Large-scale investors and more passive market
participants like pension funds and mutual funds use the
indicator to predict better when to move in to or out of a
trade with as little market impact as possible. Alternatively,
they'll use it to avoid affecting the market for the particular
instrument. To do that, large-scale investors usually sell
above the VWAP and buy below it. That way, the price is pushed
to its average rather than away from it.
The most widely spread and easiest way to use the VWAP is
quite similar to the interpretation that most traders have
of general moving averages. Prices ranging above the VWAP
line are usually reflecting bullish sentiment, while those
below the line indicate bear sentiment.
Here on this chart, we can see a green line working its
way through price. This is the VWAP line. In the red box
we have a scenario over here on the left where we had bearish
sentiment triggered by the VWAP, showing price falling
below it. Price fell below the VWAP line, and we saw bearish
activity thereafter. And on the right hand side of the screen,
we have a green box right here that indicates when price
began working its way above the VWAP line and trading
above it, and bullish momentum thereafter was followed.
Obviously, we don't simply want to buy and sell blindly just
because price is above or below the VWAP, but the VWAP
in conjunction with price action can be a very, very powerful
tool and provide a further
layer of confirmation as to whether or not we should
even be interested in buying or selling in the first place.
The VWAP is a very good representation, when it's provided
a large sample size of data, at showing us what in the world
is actually going and where is price actually heading.
Is it a serious downturn in the market?
Is it a serious upturn in the market? Or is it running directly
through the middle of the line and we're seeing a more range-bound
period, or period of some type of consolidation, or period
prior to some type of distribution? But when we work our
way below substantially, or work our way above substantially,
the read provided by the VWAP is generally a very solid
one. When we take a look at a chart that has VWAP, which
is our green line here, and a blue line, which is going to
be a simple moving average,
it starts to become a little bit more apparent that these
two are not the same thing. The VWAP indicator improves
upon the conventional moving average, like the simple moving
average, by factoring the trading volume into the price to
provide the market participants that are using the VWAP
with a better and more complete benchmark.
Its calculations are based only on new information, which
is relevant for the current market session
and it doesn't consider past data that could be outdated.
Now, if you prefer having that past data in there, then a simple
moving average might be more your speed.
They are both valuable tools for traders, but ultimately, it's
important understand how they differ. That way you can decide
which is best suited for your particular trading style and
your particular trading strategy. When plotted on a chart,
for the untrained eye, the Volume Weighted Average Price might
not look extremely different at first. We can see
that the green line and the blue line are relatively similar
in the trajectory that they're going.
But aside from this, the indicator is providing a much different
read than the blue line, which is our SMA. The difference
between the two can be described as how they're calculating
and if we look at the VWAP, summing up the prices multiplied
by the volume and then divided by the total volume, where
the simple moving average is just going to be the sum of
the closing prices divided by the number of trading periods.
Once again, that VWAP is factoring the volume in, whereas the
blue line is not paying attention to volume at all.
The VWAP is helping us reduce market impact
so it's very popular with the big institutional investors,
whereas the simple moving average is not doing anything to
that effect, and it really can't help reduce the impact. With the VWAP,
once it starts measuring, it starts fresh. With the simple moving average,
unfortunately, it is going to start with all past data. Our
VWAP is really good at helping us
identify short-term trend reflection,
whereas the Simple Moving Average might be the better tool
to analyze that long-term trend, because it includes all of
that past data. The VWAP is known to have a quick response
to the current trends because of its nature.
Whereas, the Simple Moving Average usually is going to respond
a little bit slower The key takeaway is that the VWAP is
not going to be undisputably better than the SMA overall,
it's that it's just simply different. One is an apple, one
is an orange. They both measure information in the
market and provide it in a digestible manner for us as traders,
but ultimately, we have to decide how and when to use that
information based on the current market activities, as well
as what our particular trading strategies are.
Another common question that traders using the VWAP have
is, how does it differ from other volume-weighted things, like
the Volume-Weighted Moving Average for example, instead of
the Volume Weighted Average Price?
They do sound very similar.
Well, the Volume-Weighted Moving Average is a moving average
that considers the trading activity for the given time frame
to emphasize the effect of volume on prices. The Volume-Weighted
Moving Average puts more weight on prices with high trading
activity, but on the other hand, prices surrounded by less trading
volume usually receive a lower weight by the Volume-Weighted
Moving Average. The lower weight is beneficial sometimes because it helps
identify stable trends and reliable momentum opportunities.
Although the Volume-Weighted Moving Average is a more complete
indicator than a Simple Moving Average,
both are close in the value during periods of low market
volume. That means, the Volume-Weighted Moving Average will
look quite similar to a simple moving average during those
periods where there's not a whole lot going on. We can use
the Volume-Weighted Moving Average for several purposes including
discovering emerging trends, confirming existing ones, or identifying
upcoming market reversals.
This is precisely one of the core things that makes it
different than the VWAP, which is our Volume-Weighted Average
Price. There are many other differences between both indicators,
starting with the fact that the VWMA, the Volume-Weighted
Moving Average is an updated moving average and traders often
use it in addition to an SMA. In a nutshell, the VWAP is a cumulative
of the average price in relation to volume.
Its calculation begins at the start of each training session
and it doesn't drop any data over time. Instead of the bar's
close, it uses the typical price, as in the sum of the low
close and high prices divided by 3. On the other hand, the
volume weighted moving average uses fixed periods that allow
it to drop older data. Its calculation is continuous and spans
across several sessions, unlike the VWAP, which is reset
at the start of every period. Both of these indicators aren't
mutually exclusive, just like the SMA,
they're just different ways to gather that information that
we're seeking from the market.
If we were to talk about the advantages of the VWAP itself,
one of the common things that traders will accredit it for
is the fact that it's factoring in the trading volume.
It also helps spot lows and highs to buy and sell. It can
also signal changes in market sentiment.
It can also help capture the perfect momentum to get into
a trade in relation to liquidity, transaction costs, and help
provide that best execution location.
It's useful for retail traders and large-scale investors
alike, which is another big advantage.
It's a building block for many trading algorithms,
and if you are using it, then you might be at the core of
an algorithm, giving you one step up over those who are not using it.
It can also be used as a dynamic area of support and resistance,
and it can help reduce the market impact of large-scale traders.
As far as the disadvantages of the
VWAP, it requires a vast amount of data to provide an accurate
picture. It doesn't take historical data into account, as
we discussed. Many traders only consider it reliable as a single day indicator.
It may also lead to missed opportunities in strong trends
if waiting for price to drop or rise above or below the VWAP
line, if not complemented with outside analysis.
When the VWAP is fed too much data, the VWAP line
can experience lags throughout the trading session. It also can be not reliable
if it's used on time frames that are too long,
so most traders prefer to use the VWAP on 1, 5, or 15 minute
charts because once it's used on a time frame that is much
larger than that, we start to see weird issues with the
VWAP because of its trying to calculate the opens and closes
across multiple sessions.
In conclusion, mastering the VWAP isn't going to come
overnight, but then again, really no indicator trading
strategy ever is. Using indicators to help get a better idea of what's going on
in the market, is providing us, at first, a new way to look at
the market, which means we're not supposed to be completely
comfortable or totally proficient with them right out of
the gate. The VWAP provides us an opportunity to make sure
that whenever we're buying or selling, that we're doing so
at hopefully a fair price. It gives us an idea of where those
institutional buyers and sellers might actually be placing their orders,
and this can be huge. Especially if you're trying to pass
something like the Gauntlet Mini. But until next time folks,
good luck in your trading out there.
I wish you all the best. I will see you soon. Cheers folks.