Ask 10 high-performing day traders what their favorite technical indicator is, and one indicator will make the list almost every time: the VWAP.
The VWAP can show you where the trading volume is and at what price. Trading volume and price action are too much to cover all in this post, so be sure to do your research if you need a little help with terminology.
Ultimately, the VWAP can help you find more trading opportunities and make more informed trading decisions.
If you day trade stocks and don’t yet have the VWAP indicator on your chart, then this post is for you. Read on …
What Is VWAP?
Volume-weighted average price (VWAP) is a technical indicator that shows where the majority of volume trades in a stock.
The indicator is a basic line on the chart. When the price is above the line, it’s above VWAP. And when it’s below, the price is below VWAP.
VWAP is one of the more useful indicators for day traders, as it can give a good view of whether traders who recently entered positions are profitable or losing money on their trades.
With this information, a savvy trader can then look to trade with those who are closing losing positions or ride a larger wave of momentum. There are other ways to put this number to use. More on that in a bit.
Why the VWAP Matters
VWAP sounds great, right? Or maybe you think it sounds like all the other indicators. Let’s break down what’s so special about this one …
Here are a few reasons why so many top day traders love VWAP …
- VWAP is dead simple: the price is either above it or below it. When it comes to day trading, simplicity often rules.
- It’s an easy gauge on whether a stock is cheap or expensive on the day.
- You can use it to help you pinpoint intelligent entry and exit points for your day trades.
- It can help you determine trend changes, often quicker than moving averages.
There are plenty of reasons that day traders love the VWAP. Ready to learn more? Practice, practice, practice. Load up a few charts with a VWAP and see what kind of patterns pop out at you.
Don’t have your charting set up with VWAP capabilities? Check it out on the StocksToTrade platform. A 7-day trial is just $7. Try today and see how you can use the VWAP indicator in your trades.
How to Calculate VWAP
Calculating the VWAP is pretty simple.
First, take the dollar amount traded for the entire trading volume that day (the share price multiplied by how the number of shares traded). Next, divide that number by the number of shares traded during that day.
The result is the average price compared to volume. This tells traders at which price levels the majority of volume traded. Simple, right?
VWAP Trade Examples
Now that you’re up to speed on what the VWAP is and how it’s calculated, it’s time to dive into some trading setups you can start watching for.
Here are two of our favorites:
Before we examine the VWAP breakout setup, let’s be clear about what a breakout is.
A breakout is when a stock’s price moves above a previously strongly held resistance level, often with higher trading volume. This can signal that traders are excited about this move and the stock may go on an extended price run.
When it comes to a VWAP breakout, look for when a stock price drops below the VWAP. This can often signal that buyers are exiting their long positions, which lowers the price compared to the VWAP.
This can potentially be a good situation to look for a long trade, with the expectation that the stock will soon bounce back and continue its upward movement.
What’s a pullback?
A pullback is where a stock that’s on an extended move upward or downward makes a small movement in the opposite direction. Hence, pullback.
Pullbacks are a common price movement. You can see them all over stock charts, especially in heavy trends. To trade a VWAP pullback setup, imagine you’re watching a stock that’s in a clear uptrend, consistently making higher highs and higher lows …
The stock price makes a pullback to the downside, returning to the VWAP level on the chart. This is a chance to purchase the stock at the daily average price, sort of like buying something at a one-day-only clearance sale.
After you enter your long, you’re looking for price to continue its uptrend, gradually pulling the VWAP up along with it. Everyone loves a bargain!
Tips for Using VWAP
The VWAP itself is a simple indicator. But that doesn’t mean you can just plug and play, then expect killer results.
We’ve compiled a list of some best-practice tips to help you properly use VWAP to find, enter, and manage trading opportunities:
Never Use It Longer Than 24 Hours
In fitting with the StocksToTrade trading philosophy, it’s generally best to calculate the VWAP using price data from the previous 24 hours maximum.
That means that the VWAP will only average the price and volume from recent market action.
Why? When it comes to the VWAP, less is more. You want the data for the VWAP to be finely tuned to the most recent actions of other traders in the market.
Since the VWAP is mainly a day trading tool, it’s more important to know if traders who bought today are in a profit or a loss. How traders fared the week before is less relevant here.
Use Short-Term Charts
When trading stocks, you’ll probably notice that the trading volume fluctuates throughout the day. You’ll often find the bulk of the volume just after the open and just before the close.
You might also see that a stock can be quiet for an hour, then see massive trading volume in just a minute or two. That may be due to a news catalyst or exciting price action.
Here’s what that means: If you use longer-term charts, such as the 30-minute or 60-minute, your VWAP data will greatly lag behind a shorter-term chart (think 1-minute or 5-minute here).
On a longer-term chart, the speed at which the VWAP generates a signal could mean that you completely miss the move. So, if you use VWAP, opt for the shorter-term charts.
Be Smart with Where You Place Your Stop-Loss
Any trade can be a losing trade, so you always need to know when it’s time to exit a loser.
Normally, traders place stops on the other side of a key level or the price at which their chart pattern is invalidated. But, with VWAP, it’s not so simple — VWAP can move all day. You can’t just keep your stop loss on the other side of VWAP.
Instead, here are a few ideas for setting stop-losses with VWAP:
For instance, if you take a VWAP pullback trade, you should look to place your stop-loss on the other side of a key chart level. That level may be a morning gap or previous strong support level. That way, you can use the VWAP to try to keep trading in the right direction but maintain a stop-loss at a logical level.
Alternatively, if there’s no major level, you can also look to keep your stock on the other side of a recent swing point. Imagine you’re long a stock that’s making higher highs and higher lows. You can place your stop-loss just below the previous swing low. If that low is broken, the uptrend is invalidated anyway.
You can be creative with your stop-loss placement, but make sure you test it. It should make sense for your trading plan. Backtest it before you take it live.
Take Advantage of StocksToTrade Features
Does it sound like VWAP is exactly what you’re looking for and you’re ready to add it to your charts right now? What if your charting platform doesn’t offer VWAP?
Good news! VWAP is one of the many technical indicators that are built into the StocksToTrade platform.
We offer way more than just a library of technical indicators … StocksToTrade is also jam-packed with features that can help you streamline your trading day as much as possible.
Here are just a few of the powerful features:
- Top-of-the-line scanning capabilities. Just plug in your exact trading criteria, and it’ll quickly search thousands of stocks for opportunities.
- Ultra-modern and clean charts — so easy on your eyes every trading day.
- Scan the web for any mentions of your favorite stocks, including news stories, SEC filings, and social media mentions.
- Coverage for just about every stock listed in the U.S.: NYSE, Nasdaq, pink sheets, and OTC.
- And so much more. And we’re always adding to our growing list of features.
See why some of the best U.S. stock traders use our platform every day. Grab a 7-day trial of StocksToTrade for just $7!
Has this post given you the confidence to start using the VWAP for your day trading?
It’s a truly simple indicator, but you still need particular skills to use it. The steps in this post can help you to do exactly that.
Make sure to only trade particular VWAP setups that make sense to you. You can also simply use VWAP as a filter for your other trading setups.
One last point: Any time you add a new technique or indicator to your trading strategy, make sure to paper trade it first. Some practice trials can help you work out the kinks and build more confidence with a new tool.
Most importantly, if you’re not on board, with our top-of-the-line trading toolbox, what are you waiting for? You can access top-notch charting, paper trading, and scanning abilities, and so much more. Grab a 7-day trial for just $7 today!
What are your favorite day trading indicators? Is VWAP is one of them? Leave a comment and share!