Volume is one of the most important concepts in the market. A sharper move that is not supported by higher volume tends to be a sign of a false breakout. Therefore, as the name suggests, the average price weighted by volume (VWAP) is the average price of a financial asset that is weighted by volume.
In other words, it is the dollar value of an asset’s period divided by the volume of the same period. The period is usually intraday and not several days.
Unlike other indicators like the Relative Strength Index and Stochastic, VWAP is not an indicator per se. It is a benchmark that is used together with other indicators. It is also commonly used by quantitative traders.
This indicator has been in use since 1984 when it was discovered by James Elkins, who was a trader at an investment firm known as Abel Noser.
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How do you calculate volume-weighted average price (VWAP)?
As with most indicators we have covered, knowing how to calculate the VWAP is not necessary. Instead, you should only be interested in applying the indicator and how to interpret it. There are several steps involved in calculating the volume-weighted average price.
First, you need to calculate the typical price for the intraday period. This is calculated by adding the high, low, and the close and then divide by three. The challenge for currencies is that it is difficult to calculate the close since they run for 24 hours Monday to Friday.
After calculating the typical price, you should multiply this number with the volume of the day.
The third step is to calculate a cumulative total of these prices. Finally, you should divide the running total price by the volume. A summary of this process is shown below.
|VWAP = (Typical price + volume) / cumulative volume|
In this equation, Pi and Qi are the price of the asset while Qi is the quantity.
How to Trade with the VWAP indicator
The VWAP indicator is a lagging in nature just like the moving averages and the Parabolic SAR. This means that it uses historic data to predict the future performance of an asset. As a result, the more data you input into it, the more lag you will see.
In most charting software, the VWAP indicator gives six anchor periods:
The most popular way to use the VWAP indicator is to combine it with other indicators. For example, in the chart below, we have applied the monthly VWAP indicator with the 20-day exponential moving averages.
We use 20 because the market is usually open for 20 days in a month. As such, you can observe the points where the two indicators cross one another.
For an even more complete explanation, you can watch the video published by our TraderTv partners.
We give you another help: the timing of the topics:
- 0:00 Introduction
- 0:19 Definition of Vwap and formulas
- 1:07 Explanation of Vwap with Facebook chart
- 5:31 Example – Facebook trade, Vwap as entry indicator.
Is VWAP Useful? Benefits of Using the Volume Weighted Average Price!
There are several key benefits of using the indicator. First, it is a relatively easy-to-use indicator unlike other complicated ones like the Ichimoku Kinko Hyo. All you have to do is to apply it in a chart and see the results.
Second, VWAP is easy to interpret. Most traders identify it as being bullish when the price is below the VWAP and bearish when it is above the price. The reason for this is that during an uptrend, there is more pressure to buy the price.
Third, it can be used to measure efficiency in the markets.
The volume weighted average price is not a very common indicator in the market. In fact, very few traders know anything about it. Still, it is used by some of the most experienced intraday traders in Wall Street.
Also, since it is not installed as a default in most platforms, you must download and install it directly.