VWAP (Volume Weighted Average Price) is one of the most important indicators for day traders and institutional investors. Unlike simple moving averages, VWAP accounts for volume, giving you a more accurate picture of the true average price. In this guide, we will explain everything you need to know about VWAP.
What is VWAP?
VWAP is the average price of a stock weighted by volume throughout the trading day. It tells you the average price that traders actually paid for shares, not just the average of high and low prices. This makes VWAP a more realistic benchmark for evaluating trade quality.
Why VWAP Matters: If you bought shares below VWAP, you paid less than the average trader. If you bought above VWAP, you paid more. Institutional traders use VWAP to measure execution quality.
How VWAP is Calculated
VWAP is calculated by adding up the dollars traded for every transaction (price times shares) and dividing by the total shares traded:
VWAP Formula
VWAP = Cumulative (Price x Volume) / Cumulative Volume
For each period, the typical price (high + low + close / 3) is multiplied by volume, then cumulated throughout the day.
Why Traders Use VWAP
For Institutional Traders
Large institutions use VWAP as a benchmark for their trades. Their goal is often to execute at or better than VWAP. Buying below VWAP or selling above VWAP is considered good execution.
For Day Traders
Day traders use VWAP as dynamic support and resistance. When price is above VWAP, the trend is considered bullish. When price is below VWAP, the trend is considered bearish.
For All Traders
VWAP serves as a fair value indicator. It represents the price where volume and price are in balance. Moves far from VWAP often revert back toward it.
Trading with VWAP
VWAP as Support and Resistance
VWAP acts as a magnet for price. Strong stocks tend to stay above VWAP, while weak stocks stay below. Price often bounces off VWAP or uses it as a pivot point.
Example: VWAP Support
Stock ABC gaps up at the open and trades above VWAP all morning. Around 11:00 AM, it pulls back to test VWAP. The stock finds buyers at VWAP and bounces, confirming bullish strength.
VWAP Crossovers
When price crosses above VWAP, it is a bullish signal suggesting buyers are in control. When price crosses below VWAP, it is bearish, suggesting sellers are in control.
Example: VWAP Crossover
Stock XYZ opens below VWAP and trades weakly for the first hour. At 10:30 AM, price breaks above VWAP with strong volume. This crossover signals a shift from bearish to bullish sentiment.
VWAP Trading Strategies
Strategy 1: VWAP Bounce
Trade bounces off VWAP in the direction of the trend.
- In an uptrend (price above VWAP), buy when price pulls back to VWAP and shows signs of bouncing
- In a downtrend (price below VWAP), sell short when price rallies to VWAP and shows rejection
- Place stops beyond VWAP to protect against trend changes
Strategy 2: VWAP Breakout
Trade VWAP crossovers for momentum plays.
- Buy when price breaks above VWAP with increasing volume
- Sell short when price breaks below VWAP with increasing volume
- Best when combined with other breakout signals like breaking chart patterns
Strategy 3: VWAP Reversion
Trade extreme moves away from VWAP for mean reversion plays.
- When price extends far above VWAP, look for signs of exhaustion to fade the move
- When price extends far below VWAP, look for signs of capitulation to buy the dip
- Use VWAP standard deviation bands to identify extreme moves
VWAP Standard Deviation Bands
Many traders add standard deviation bands around VWAP, similar to Bollinger Bands. These bands help identify overbought and oversold conditions relative to VWAP.
- First band (1 SD): Normal trading range. Price often oscillates between these bands.
- Second band (2 SD): Extended move. Price reaching these bands suggests overextension.
- Third band (3 SD): Extreme move. Rarely reached, often signals climax.
Anchored VWAP
Anchored VWAP lets you start the VWAP calculation from a specific point rather than the beginning of the day. This is useful for tracking the average price from significant events.
Anchored VWAP Uses
- Anchor to earnings announcement to track post-earnings average price
- Anchor to a major high or low to track average price since the pivot
- Anchor to a gap to track where gap buyers and sellers are positioned
VWAP Limitations
- Intraday only: Traditional VWAP resets each day, so it is primarily a day trading tool
- Lagging indicator: VWAP is based on past data, so it lags current price action
- Less useful in choppy markets: Price crosses VWAP frequently in ranging markets
- Time of day matters: VWAP is less stable early in the day when there is less data
Tips for Using VWAP
- Wait for confirmation: Do not trade every VWAP touch. Wait for price action confirmation.
- Consider time of day: VWAP is more reliable after the first 30-60 minutes of trading.
- Combine with other tools: Use VWAP with price patterns, other indicators, and support/resistance.
- Watch for volume: VWAP signals are more reliable when accompanied by significant volume.
- Know the trend: Trade in the direction of the overall trend relative to VWAP.
Track Your VWAP Performance
Pro Trader Dashboard helps you analyze your trade execution relative to VWAP. See if you are consistently buying below VWAP and selling above it.
Summary
VWAP is an essential tool for day traders and institutions alike. By weighting price by volume, VWAP provides a true benchmark of where the market traded. Use VWAP as dynamic support and resistance, trade crossovers for momentum, and watch for mean reversion when price extends far from VWAP. Combined with other technical tools, VWAP can significantly improve your trading decisions.
Continue learning about volume analysis with our guides on Volume Profile and Relative Volume.