Effective trading is possible only if you know the basic principles of the market and form trends. Through this article, you will learn about the VWAP indicator.
From beginners to pros - using the volume-weighted average price indicator effectively
Modern trading has many strategies and ways to monitor market dynamics and anticipate developments. One of these tools is the volume-weighted average price indicator. This indicator shows how active market players are in a certain period. It is best to use this indicator as an additional auxiliary tool because it will not show the current direction of value and will not help to forecast its movement in the future. But it says that the current price movement is not supported by deals and that the trend will reverse soon.
What is the volume-weighted average price - VWAP?
The weighted average price helps the investor to determine the trading volumes that are present in the market at the moment for the selected asset. If you compare trading in the foreign exchange and stock markets, you can immediately find a significant difference.
In the stock market, you can see how much a stock is buying or selling. In the foreign exchange market, it is difficult to determine what volumes are currently being traded. For this reason, instruments are being developed for the foreign exchange market that can calculate this indicator.
In the foreign exchange markets, the number of purchase transactions that investors concluded in one unit of time is calculated. Such instruments have a task - to determine the activity of market players. The VWAP indicator has a similar principle.
It is important for a professional trader to understand how the volume-weighted average price algorithm works, and in what cases it is formed. VWAP can occur for some reason. For example, an uptrend in the market. To determine it, you can use additional indicators, but you can be guided by intuition. When the cost rises for a long time, then there is a clear trend. The cost falls below the VWAP moving average. For a downward trading process, the rules are reversed.
When the volume in the market decreases, sideways movement often begins. The interest of speculators in a trading asset is significantly reduced. This says that either investor has satisfied their interest in the asset, or they are in uncertainty. After any decrease in volumes, their growth begins. This process is accompanied by the manifestation of market players' interest in a particular asset. The dynamics of volume growth does not demonstrate exactly what interests traders have: to sell or buy a trading instrument.
The advantages and disadvantages of a volume-weighted average price strategy
Of course, any approach has strengths and weaknesses. This must be understood and learned before using it. VWAP has significant advantages over traditional sliders. The tool performs an intraday calculation, which is mainly used by HFT algorithms and institutional investors to assess where stocks are trading concerning the average daily volume. Intraday speculators use volume-weighted average price calculation to estimate the market direction and filter out trading signals.
However, the indicator also has certain weaknesses. The main disadvantage of VWAP was the lag, which is associated with the used cumulative formula. For example, if a five-minute chart is used, then after four hours of the trading process, VWAP will be calculated for 48 periods. The associated lag will be similar to 48 periods of the moving average.
As volume accumulates for an hour, this lag will increase, and at the end of the day, it will have the highest rate. This is because the calculations use so much information that the new data has very little impact. Therefore, the VWAP is of great value to retailers at the beginning of the day, as it is more sensitive to value movements.
Volume-weighted average price indicator rules
The meaning of the indicator is that the location of the price chart relative to the VWAP indicator line indicates the strength of sellers or buyers. The higher the price from the VWAP curve, the stronger the bulls' influence on the market. If the price is significantly below the VWAP, then bears dominate. The VWAP indicator line often acts as a support or resistance level, and a breakout of this level means a change in the local trend and serves as a buy or sell signal.
It is very easy to make a mistake when detecting a trend change on small time frames, so more experienced traders use VWAP standard deviations for the Trend strategy. It is believed that a breakout of the second square deviation is a fairly reliable signal to buy or sell. Extreme square deviations show that the price has reached the border of the corridor and may soon change the direction of the trend. In the phase of price consolidation, the Reverse Strategy algorithm is often used, which is based on the fact that at the maximum deviation, the price returns to the VWAP indicator curve.
The VWAP indicator calculates a volume-weighted value. This allows us to assert that its indicators correspond to more or fewer places with high liquidity. Therefore, it is possible to identify potential entry points within the day, which are used by major players. Since the indicator does not display the trend direction, additional analytical tools should be used.
In addition to the main indicator curve, additional moving are often used, which are equidistant from it at a certain distance up and down. They show overbought and oversold areas. A signal to sell can be considered the intersection of the upper MA, and the signal to buy - the lower one.
Position entry evaluation is another way to apply VWAP. It is considered a good principle when a purchase is made when the indicator is on top. It turns out that the position was opened below the average value. A sale made under a moving-away is also considered successful.
The VWAP indicator is used most often for intraday trading. It should be borne in mind that when the end of the session approaches, the amount of information in the calculation accumulates. This explains the peculiarity of the indicator in the form of a gradual decrease in sensitivity during the day. It is recommended to use a volume-weighted average price market value/quantity indicator in commodity and stock markets. When trading currency parameters, there can be quite significant errors. Following these principles, you can achieve the greatest trading efficiency.