One of the most useful instruments to fight this problem is the Volume Weighted Average Price, also abbreviated as the VWAP indicator. This link to help will provide precious indicators to assist a trader in recognizing whether he pays too high or too low compared to the average price in the market throughout the day of trading. Unfortunately, though, many traders do not manage to get a grip on it in the way they should; they are missing the point of its real benefits.
In this article, we discuss a master VWAP trading strategy that you can apply to maximize your trading decisions within just eight minutes. It shall enable you to make better leverage by exploiting the functionalities of the VWAP indicator, thus helping you better maneuver through the highs and lows in the market.
What is VWAP?
VWAP stands for Volume Weighted Average Price. This is calculated like a moving average but with the inclusion of price and volume data to offer a dynamic average price that changes over the course of the trading day. A moving average does not help in giving more weight to prices of higher volume trades, but VWAP will be favored by institutional traders.
This is a mean reversion indicator for day trading, resetting at the beginning of each trading session because it sets a new baseline for the day. A one-minute chart will permit close analysis of the price action against the VWAP line for the identification of key trading opportunities.
The Principles of VWAP Trading
What is VWAP? The key concept behind VWAP trading really speaks for itself:
- Price above VWAP: When the price of the commodity is above the VWAP line, it means that traders are paying more than the average price. Such a condition usually represents overbought, thus representing a great opportunity to short.
- Price below VWAP: When the price of the commodity is below the VWAP line, it means the traders are paying less than the average price, thus representing oversold conditions and good chances to buy.
To add some extra touch to a VWAP trading plan, add two lines of standard deviation above and below the VWAP. That’s where the magic is.
- Greater and Lesser Standard Deviations: When you graph these two lines, you have limits indicating the price extremes. Once the price has been driven sufficiently away from the VWAP, in either direction above or below the standard deviations, it is a buying or selling signal, respectively.
Trading Strategy
- Buy Signal: You should buy when the price moves two standard deviations below the VWAP. At this point, a signal is a sign of an extreme price level such that you are prone to expecting a bounce back towards the VWAP.
- Sell Signal: Sell when the price moves two standard deviations above the VWAP; at this point, there will be a tendency for correction back towards the average.
You can time your trades in any of the three varieties described above. In VWAP trading, the right side of time is essential. Therefore, here are a few guidelines to find optimized entry:
- Do Not Trade During the Market Open: The first part of the market open tends to be quite volatile and skews the VWAP number. Wait at least 15 to 30 minutes after the open so that VWAP settles.
- Identify Confirmed Trends: Once the market stabilizes after the initial shock and enters into a stage where more identifiable trends are established, trading during the consolidated stage after the first 30 minutes becomes a more reliable signal.
- Be Aware of the Market: Stay updated about the overall market activity and news events that could have a bearing on price actions. VWAP is a lagging indicator; thus, awareness of the extraneous factors is quite essential.
The VWAP Strategy Steps
To trade the master VWAP strategy, use the following steps:
- Set Up Your Chart: Use a one-minute chart and add the VWAP indicator with standard deviation lines for both the upper and lower standard deviations. In doing this, you will get a clear view of what’s happening in price action over the course of the trading day.
- Finding Extremes: Throughout the course of the day, pay attention to where price is in relation to the VWAP and its standard deviations. That is the time the price is going to touch or cross through those lines.
- Validate with Other Indicators: Though the VWAP itself is a strong tool, its strength lies in using it in conjunction with other technical indicators, such as the RSI or Moving Averages, to confirm your entry/exit signals.
- Control Your Risk: Use stop-loss orders so that you can better manage the risk. Set your positions just beyond the VWAP or standard deviation lines so that in case the market moves against your position, your capital will be safeguarded.
- After Executing Your Trades: Look at your performance and change strategy if necessary. Continuous learning and adaptation make up the bedrock of successful day trading.
Conclusion
This is a very powerful day trading tool that enables someone to fine-tune his trading precision with the decision-making processes. It uses the VWAP indicator and its standard deviations to identify optimal entry and exit points, which then enhance the possibility of being in the green zone.
You will be able to use the VWAP to your advantage by dodging the noisy opening phase of the market and by taking trades through established trends. Just remember, however, that the VWAP is supposed to act as a proxy for the mean reversion which will guide your trades.
It would take time to put this strategy into your trading routine, but it will pay off because it can give you better results than before.
