VWAP (Volume Weighted Average Price) is one of the most important indicators for day traders and institutional investors. Unlike simple moving averages, VWAP incorporates both price and volume, giving you insight into the true average price paid by market participants throughout the trading day.
What is VWAP?
VWAP is the average price of a security weighted by volume. It shows the average price that buyers have paid for shares throughout the day. VWAP resets at the start of each trading session, making it particularly useful for intraday trading.
Simple concept: VWAP tells you the average price that traders actually paid for a stock, accounting for how much was traded at each price level. Higher volume transactions have more impact on the VWAP calculation.
How VWAP is Calculated
VWAP is calculated by adding up the dollars traded for every transaction (price multiplied by volume) and then dividing by the total shares traded:
- Typical Price = (High + Low + Close) / 3
- VWAP = Cumulative (Typical Price x Volume) / Cumulative Volume
The calculation is cumulative, meaning it includes all trades from market open to the current time.
Why VWAP Matters
1. Institutional Benchmark
Large institutional traders use VWAP as a benchmark for their executions. They aim to buy below VWAP and sell above VWAP. Understanding this helps you anticipate institutional activity.
Institutional Perspective
If a fund needs to buy 1 million shares and their average execution price is below VWAP, they have outperformed the benchmark. This means they got a better deal than the average market participant.
2. Fair Value Reference
VWAP represents a fair price for the trading session. Price trading above VWAP suggests bullish sentiment, while price below VWAP indicates bearish sentiment.
3. Dynamic Support and Resistance
VWAP often acts as support in uptrends and resistance in downtrends. Traders watch for price reactions at the VWAP level.
How to Use VWAP in Trading
1. Trend Identification
- Price above VWAP: Bullish bias - look for long opportunities
- Price below VWAP: Bearish bias - look for short opportunities or avoid longs
2. Entry and Exit Points
- In uptrends, buy pullbacks to VWAP
- In downtrends, sell rallies to VWAP
- Use VWAP as a stop loss reference level
VWAP Pullback Trade
Stock opens strong at $50, rallies to $52, VWAP is at $51.
Price pulls back to $51 (VWAP) and bounces.
Entry: Buy at $51.10 when price shows support at VWAP.
Stop: Below VWAP at $50.80.
Target: Previous high at $52 or higher.
3. VWAP Bands
Some traders use standard deviation bands around VWAP (similar to Bollinger Bands). These bands help identify:
- Overbought conditions when price reaches upper bands
- Oversold conditions when price reaches lower bands
- Mean reversion opportunities
VWAP Trading Strategies
VWAP Bounce Strategy
- Identify stocks in a clear intraday trend
- Wait for price to pull back to VWAP
- Look for bullish candlestick patterns or volume confirmation
- Enter in the direction of the trend
- Place stop loss on the other side of VWAP
VWAP Breakout Strategy
- Watch for stocks consolidating near VWAP
- Enter when price breaks decisively above or below VWAP
- Confirm with increased volume on the breakout
- Use VWAP as your stop loss reference
VWAP Late in the Day
VWAP becomes less meaningful as the trading day progresses because more data points make it harder to move. In the last hour of trading, VWAP tends to flatten and may be less useful for entries.
Opening Range with VWAP
- Wait for the first 15-30 minutes to establish an opening range
- If price is above VWAP after the opening range, look for longs
- If price is below VWAP after the opening range, look for shorts
- Use VWAP as confirmation of the day's direction
VWAP vs Simple Moving Average
Key differences between VWAP and SMA:
- Volume weighting: VWAP accounts for volume; SMA treats all prices equally
- Reset: VWAP resets daily; SMA is continuous
- Timeframe: VWAP is intraday; SMA works on any timeframe
- Usage: VWAP for day trading; SMA for swing and position trading
Anchored VWAP
Anchored VWAP allows you to start the calculation from any specific point, not just market open. Common anchor points include:
- Earnings announcements
- Major highs or lows
- Gap openings
- News events
This variant is useful for swing traders and longer-term analysis.
Limitations of VWAP
- Only useful for intraday trading (unless using anchored VWAP)
- Becomes sluggish late in the trading day
- Less effective in low-volume stocks
- Lagging indicator - it follows price, does not predict it
- Can give false signals in choppy markets
Best Practices for VWAP Trading
- Focus on liquid stocks with significant volume
- Most effective in the first few hours of trading
- Combine with other indicators for confirmation
- Use VWAP bands for better entry precision
- Consider the overall market direction
- Do not fight strong trends just because price is far from VWAP
Track Your VWAP Trades
Pro Trader Dashboard helps you analyze your VWAP-based entries and identify which setups work best for your trading style.
Summary
VWAP is an essential tool for day traders, showing the volume-weighted average price throughout the trading session. It serves as a benchmark for institutional traders, a fair value reference, and dynamic support/resistance. The most effective VWAP strategies include trading pullbacks to VWAP in trending markets and using VWAP as a directional filter. Remember that VWAP is most useful early in the trading day and should be combined with other analysis techniques for best results.
Learn more: Volume Analysis and Level 2 Quotes.