The Volume-Weighted Average Price (VWAP) indicator is a technical tool that measures intraday prices relative to the trading volume occurring at each price.
As a Volume Indicator , the VWAP offers a very valuable set of simple supplemental information that many technical traders often overlook.
Retail traders often overlook trading volume indicators because they do not know how to relate them to the price action of a stock.
The VWAP indicator is ideal in this scenario because the relationship between volume and price is built directly into the technical indicator itself, which is why it is one of the most popular indicators.
What Is the VWAP Indicator For?
The VWAP indicator is used mainly as a last-minute trade confirmation tool.
Since the VWAP only offers trading day information, it is most useful in identifying the best trade entry points and trade exit points for trades that were identified using other technical analysis indicators, such as resistance levels or Bollinger Bands.
Even institutional traders who make long-term investment decisions and shun most technical analysis indicators will use the VWAP in conjunction with fundamental analysis to confirm their entry points and exit points for that trading day.
Most short-term traders use the VWAP in the intraday time period to confirm scalping trades, where they are looking to make a quick profit without getting caught in large trend movements.
While the VWAP is only relevant to intraday charts, it is always ideal to use it right before any trade to ensure that there are no recent price shifts that will soon revert back to the day’s average.
The universal applicability and simplicity of the VWAP indicator are what make it one of the best trading indicators for all traders on any trading platform.
A Breakdown of the VWAP Indicator
The VWAP is among the simplest indicators available to traders.
The Volume-Weighted Average Price is exactly what it sounds like: the average stock price over the intraday time period weighted by the volume of trades.
VWAP Calculation
There are 5 steps to the calculation of VWAP using daily charts:
- Find the typical price for each intraday period, usually 5-minute periods. The typical price is calculated as the average of the price high, the price low and the closing price for that period.
- Multiply the resulting typical price for the period by the volume for that period.
- Maintain a running total of this result. This is the cumulative total.
- Maintain a running total of the volume traded. This is the cumulative total volume.
- Divide the cumulative total by the cumulative total volume.
Cumulative Total [(Volume) (Typical Price)] / Cumulative Total Volume
The Implications of the VWAP Formula
The implications of the VWAP formula are that for any period of the day, a trader has access to the most common price traded so far for that day.
The VWAP may diverge significantly from the current price level if recent price movements were made at low volumes.
By normalizing the average price for any period against the volume, the VWAP offers traders far more detailed insight into that stock’s actual price action for the day.
How to Use the VWAP Indicator?
The VWAP has a number of uses, but as an intraday technical indicator it is mostly useful for short-term trading or finding the optimal point for potential entry and exit from long-term trades.
Traders across all preferred timeframes will find potential trading opportunities using other tools and then confirm the trade using the VWAP indicator.
More specifically, the VWAP volume indicator helps short-term traders identify price action anomalies that are caused by low-volume trades.
For example, a stock can be trading in large volumes around $5 all day and then have a sudden price jump to $6 based on a very small volume of trades.
An intraday trader who only sees the price chart may think that a sudden change in the market has occurred.
However, a day trader who supplements their intraday price movement with the VWAP indicator will see that this price change has significantly diverged from the VWAP.
Significant divergences between the price and the VWAP signal that the price moves do not have much strength behind them.
The Best Tools for the VWAP Indicator
The ease-of-use and broad applicability of the VWAP indicator make it one of the most powerful tools available to traders.
No matter what the trade timeframe is, it is always wise to check the VWAP before opening or closing a trade to ensure that you are getting the best possible price for that day.
The VWAP is so simple to understand and use that it is available on almost every trading platform, so every trader should be using it regardless of the sophistication of their trading platform.
Our top recommendation for simple trading platforms for retail traders is:
As universally applicable as the VWAP is, it is generally only useful for trade setups that were made using other indicators.
To make the most of the VWAP, traders need the full suite of technical indicators to develop their full trading strategy.
Our top recommendations for market research tools for retail traders are:
Since wise retail traders will be using the VWAP before they open and close each trade, that is also a good opportunity to log the trade in a trade journal for analyzing your strategy’s performance.
Our top recommendation for trading journal tools for retail traders is:
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