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How to Level Up Your Trading with VWAP
Of the thousands of indicators out there, few are more popular or widely used than the Volume-Weighted Average Price, or VWAP. The simple reason for this is that volume is the factor that drives momentum which, in turn, pushes prices higher or lower. While there are many indicators that utilize a volume component; Volume, On-Balance Volume (OBV), and TrendSpider’s own Volume-By-Price, to name just a few, the Volume-Weighted Average Price (VWAP) is certainly the most popular because it combines price and volume to show you who’s in control of the market at any given point in time.In this blog post, we’ll break down both the standard VWAP and Anchored VWAP indicators. We’ll touch on how they are calculated and provide unique examples of how traders of all kinds utilize them within their trading systems.
What Is The Volume-Weighted Average Price (VWAP)?
The volume-weighted average price, or VWAP, is a popular indicator used by market participants of all kinds; From short-term to long-term holders, retail to professional investors, and manual to algorithmic traders. While it looks similar to a moving average, the VWAP factors volume into its calculation, providing greater insight into market movements. The VWAP indicator is typically drawn as a single line on intraday or daily charts and is used to track the average price, as weighted by volume, at any given time. When price is trading above the VWAP, buyers are considered to be ‘in control’, whereas when price is trading below the VWAP, sellers are considered to be ‘in control’.
VWAP is calculated using these steps:
- Find the Typical Price (TP) for each period (e.g. (High + Low + Close) / 3).
- Multiply the Typical Price by the Volume (e.g. TP * V).
- Calculate the VWAP by keeping a running total of the TP and Volume and applying the formula; Cumulative TP * V / Cumulative Volume.
This calculation produces a volume-weighted average price for each period (candle), which then is overlaid on the candlestick chart to form the indicator that traders and investors use.
How The VWAP Is Used
Traders of all skill levels utilize the VWAP, but different styles of traders utilize it in different ways.
Institutional traders use the VWAP to move into and out of stocks with a minimal price impact, as well as to gauge when price is too extended. For example, they may buy below the VWAP or sell above the VWAP to push the price back to an average instead of away from it. This helps them to maintain an orderly market.
Short-term traders use the VWAP to determine levels of support or resistance. If price is trading above VWAP and comes back to it, a short-term trader might look for it to act as support. If price is trading below VWAP and trades back up into it, a short-term trader might look for it to act as resistance.
Swing and position traders use the VWAP in the same way as a moving average. For example, they may look for crossovers between the VWAP and the stock price, either as a trading signal or simply as one variable within a larger trading system.
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Anchored VWAP By AlphaTrends
Technical analysis is dependent on the belief that the price has memory. If the price breaks through a prior resistance level, market technicians believe that the prior resistance level becomes a support level. The rationale is simple: Humans have an inherent anchoring bias that causes us to rely heavily on the most impactful piece of information.
Brian Shannon’s Alphatrends Anchored VWAP, or AVWAP, makes it easy to adjust the VWAP based on a specific moment when the market may have experienced a significant or impactful event. For example, you may want to anchor a VWAP to a reaction high or low, a gap up or down, a high-volume candle, or another important inflection point that represents a “new normal” for the stock you’re interested in trading.
TrendSpider makes it easy to use the AVWAPs with several unique settings. You can add an AVWAP to your chart using two different methods; Manually or automatically. For the manual method, simply right-click on the candle you wish to anchor from and choose the ‘Create Alphatrends Anchored VWAP here’ prompt.
There is no limit to the number of manual and/or auto-anchored VWAPs you can add to your charts, but auto-anchored VWAPs will appear on every chart that you scroll through whereas manually-anchored VWAPs will only appear on the chart that you add them to. This is by design and is the nature of the two different AVWAP options.
AVWAP Strategies & Examples
The AVWAP opens the door to many new strategies since you can create multiple VWAPs that start from different anchoring points.
AVWAP Pinch
The example below shows an AVWAP “Pinch” (coined by Brian Shannon), which creates a range for the price prior to breaking out higher or breaking down lower. The AVWAPs in this example are anchored to the reaction low and reaction high over the visible timeframe. Though price could break in either direction, the longer it stays within the pinch, the more powerful the move out of the pinch can be.
AVWAP With Percentage Bands
You can also introduce percentage-based AVWAP band offsets to create a margin of error around the primary AVWAP line. If you’re creating an automated trading strategy, these margins of error can help you avoid narrowly missing price moves. To further assist traders, alerts can be set on any of these lines, the AVWAP or its corresponding percentage bands, by right-clicking on the line of choice and choosing the ‘Create an alert at this line’ option.
The example below shows AVWAP bands created from the weekly swing high and low with percentage bands set at 1%, 2%, -1%, and -2% offset levels to create a margin of error.
In addition to these bands, you can create:
- Standard deviation bands with four default settings inspired by Fibonacci levels.
- Percentage bands with four default settings inspired by Fibonacci levels.
- Alphatrends VbP Ribbon with variable line thickness based on the amount of volume found at the price relative to the entirety of the line.
AVWAP Continuous Re-Anchoring
Traders that want to anchor VWAPs to reaction highs or lows can use continuous anchors to adjust the anchor points over time. For example, TrendSpider provides a “continuous” setting where each blue raindrop re-anchors the VWAP.
In addition to blue raindrops, you can auto-anchor AVWAPs to:
- Highest volume candle in a candle range
- Highest high in a candle range
- Lowest low in a candle range
- Most recent blue doji raindrop candle
- A recent gap
- Day-to-date (since today’s open)
- Week-to-date (since open at start of week)
- Month-to-date (since the start of the month)
- Quarter-to-date (since the start of the quarter)
- Year-to-date (since January 1)
TrendSpider also makes it easy to create dynamic price alerts on and backtest AVWAP lines that are automatically re-anchored without any added effort.
AVWAP’s From Previous Swings
Using the ‘Draw Volume-By-Price’ tool, which creates an anchored VWAP from the point that the drawing starts, you can even use AVWAPs created from a specific period to create a support or resistance level for a future period. In the example below, we calculate the AVWAP between the previous swing high and low and that price becomes a key resistance level on the reversal move lower.
The Bottom Line
The volume-weighted average price makes it easy to spot price and volume trends over time. While the VWAP is commonly used by day traders and as part of trading algorithms, the Alphatrends Anchored VWAP has become a popular derivative indicator for traders of all kinds who use a wide array of different strategies.
In addition to VWAP and AVWAP, TrendSpider provides several other volume-based indicators, including our proprietary Raindrop charts, which incorporate volume into traditional candles to yield a whole new level of insight.
As always, if you have any questions, feel free to reach out to us via the ‘Contact Us’ button in the bottom right-hand corner of your chart.
