VWAP (Volume Weighted Average Price) is a popular technical indicator used by traders to measure the average price of a security over a given period, weighted by the trading volume during that period. Trading with VWAP involves using the indicator to identify potential support and resistance levels, as well as to generate trading signals.
Here are some general steps on how to trade with VWAP:
- Identify the VWAP: VWAP is usually plotted as a line on a price chart, so the first step is to identify this line on your chart.
- Use VWAP as a reference point: Traders often use VWAP as a reference point to determine the fair value of a security. If the price is trading above VWAP, it suggests that the security is overvalued, while if it is trading below VWAP, it suggests that the security is undervalued.
- Look for price action around VWAP: Traders also look for price action around the VWAP line. If the price repeatedly fails to move above VWAP, it could be a sign of resistance, while if the price repeatedly fails to move below VWAP, it could be a sign of support.
- Use VWAP as a trade entry/exit signal: Traders also use VWAP as a trade entry or exit signal. For example, if the price crosses above VWAP, it could be a buy signal, while if it crosses below VWAP, it could be a sell signal.
- Combine VWAP with other indicators: It is important to note that VWAP should not be used in isolation. Traders often combine VWAP with other technical indicators such as moving averages, Bollinger Bands, or Relative Strength Index (RSI) to get a more comprehensive view of the market.
- Set stop-loss orders: As with any trading strategy, it is important to manage risk by setting stop-loss orders to limit potential losses.
It is important to note that trading with VWAP requires experience and practice, and it is not a guaranteed way to make profits in the market. It is important to develop a trading plan that incorporates VWAP and other indicators, and to consistently stick to that plan.
Here is an example on how to trade with VWAP
- Identify the VWAP: First, identify the VWAP line on your chart. In this example, we will use a 20-day VWAP.
- Look for price action around VWAP: Look for price action around the VWAP line. If the price is trading above VWAP, it suggests that the security is overvalued, while if it is trading below VWAP, it suggests that the security is undervalued.
- Use VWAP as a trade entry/exit signal: Use VWAP as a trade entry or exit signal. For example, if the price crosses above VWAP, it could be a buy signal, while if it crosses below VWAP, it could be a sell signal.
- Combine VWAP with other indicators: Combine VWAP with other technical indicators to get a more comprehensive view of the market. In this example, we will use the Relative Strength Index (RSI).
Here is a step-by-step guide to the VWAP trading strategy:
Step 1: Identify the VWAP line on your chart
In this example, we will use a 20-day VWAP on the daily chart of the stock AAPL.
Step 2: Look for price action around VWAP
We can see that the price is oscillating around the VWAP line, suggesting that the security is trading close to its fair value.
Step 3: Use VWAP as a trade entry/exit signal
We can use the VWAP line as a trade entry or exit signal. For example, if the price crosses above VWAP, it could be a buy signal, while if it crosses below VWAP, it could be a sell signal.
In this example, we can see that there were several buy signals when the price crossed above the VWAP line, and several sell signals when the price crossed below the VWAP line.
Step 4: Combine VWAP with other indicators
We can combine VWAP with other technical indicators to get a more comprehensive view of the market. In this example, we will use the Relative Strength Index (RSI).
The RSI is a momentum oscillator that measures the strength of a security’s price action. A reading above 70 is considered overbought, while a reading below 30 is considered oversold.
We can see that when the price crossed above the VWAP line and the RSI was above 70, it could be a sell signal, while when the price crossed below the VWAP line and the RSI was below 30, it could be a buy signal.
In summary, the VWAP trading strategy involves using the VWAP line to identify potential support and resistance levels and generate trade signals, and combining it with other technical indicators such as the RSI to get a more comprehensive view of the market. It is important to remember to manage risk by setting stop-loss orders to limit potential losses.