Trading Toolkits: Volume-Weighted Average Price (VWAP)

Understanding how these averages work will benefit traders who are trying to extrapolate token prices.

Introduction

Trading indicators are the lifeblood of technical analysis. Traders use these simple and sophisticated tools to determine their entry or exit, the market conditions, or the current trends. The VWAP tool indicates the amount of liquidity available at a given period in the market on a specific trade. Application of the VWAP could help traders hinge closer to nailing correct entries or exits.

What is Volume-Weighted Average Price (VWAP)?

As the name implies, it’s the average price of the asset/market for a given period weighted by volume. It combines volume plus price action to give an idea about the presence of liquidity in a trade.

Its utility is in its ability to determine the market trends, combine the effective strategies of both volume and price action, and give a near correct direction to a trader. Certain crossing on the VWAP can determine a trader’s action, indicating the most profitable trades they can make.

How to Calculate VWAP

As with other indicators available in the chart, VWAP tools are pre-installed in platforms like TradingView or certain exchange trading interphases,pre-installed, such as Binance.

It’s best to learn how to calculate this if you intend to go manual or in the case you get to use a chart without an already installed VWAP tool.

To calculate the VWAP,  add up the traded value for each transaction (price multiplied by volume), then divide that by the total volume.

VWAP =  Typical Price * Volume  / Volume 

Typical Price = High + Low + Close / 3

Let’s pick a 5-minute candle and determine the VWAP of that trade.

First, calculate the typical price for the first 5-minute candlestick. Add the High, Low, Close, and divide the number by 3.

Compute the volume with the typical price for that period (in this case, 5 minutes). Tagging this value n1, as it relates to the first measured period.

Divide the result by the total trading volume up until that period. This gives the VWAP value for the first 5 minutes of trading.

To calculate the corresponding VWAP values, continue adding the new n values (n2, n3, n4…) from each period to the initial values. Then divide that by the total volume up until that point.

By this, we can now understand why the VWAP is called an additive indicator, as the values are increasing by successive additions.

The Significance of VWAP

High volume traders use the VWAP to set their entry or exits and determine a less impact period to enter trades as this type of high volume trade can impact the overall market.

Similar to the Moving Average indicator, VWAP works by the crossing of the VWAP line. For example, VWAP crossing above indicates a buyers market; typically, traders would buy when this happens as this shows the market is ready to go long. In the case of the line crossing below, it indicates a seller market meaning the market is about to go short.

This means that a properly timed market will help traders get in and out with the best prices just when the market is about to break out of its previous trends.

The Appeal of VWAP

VWAP is about the only tool in Technical Analysis that combines both Volume and Price Action. These are two powerful indicators many traders use in isolation, but now can be combined into one tool.

Traders can determine key market components and drivers with one glance or calculation, including the volume, available liquidity, and the current trend.

Possible Weaknesses

As with other indicators, VWAP does not work best in isolation but with other tools. The tool uses historical price data to predict price movements, and as such, what happened in the past may not repeat. Thus the tool doesn’t have stark predictive qualities.

The VWAP tool is a single day/intraday trading tool, i.e., it is best applied in Day Trading. Trying to create a VWAP across multiple days will mean that the average price is distorted.

Like moving averages, the VWAP is a lagging indicator, as is based on past price data. Similarly to a moving average the more the data, the greater the lag. Due to this, a 5-minute VWAP will react more quickly to current price movements than a 100-minute VWAP.

In Conclusion 

VWAP is one of many indicators available to a trader showing the volume of a trade/market relative to the price action. It is best used in combination with other tools and not isolated as it doesn’t have stark predictive qualities.

Some traders may determine their entry or exit based on the crossing of the lines; however, no matter the tools, risk management is an important principle to apply.

Source : bsc.news