July 23rd Chart Decoder Series: VWAP – Market Truth Detector

Welcome to the Chart Decoder series. Here we categorize tools that separate casual traders from professionals.

You have already mastered trend identification (SMA/EMA), momentum shift (MACD), excessive/sold out zones (RSI), extreme extreme extremes (bollinger bands), and inversion timing (probability).

Now it’s time for VWAP, an indicator that cuts Now and tells you one simple thing. Are you overpaying?

What is VWAP?

VWAP represents the volume weighted average price. It shows you the average price everyone paid today, but gives you more weight to the price where many transactions have happened.

Bitcoin spiked quickly to $110,000, but only a few people bought there, most people traded about $105,000 on a major buying and selling, while VWAP is way closer to $105,000.

The concept of calculation is simple.

• Do all trades all day
• Multiply the price x volume for each transaction
• Add them all and split them by total amount

What you get is a “true” average price that reflects where most of the money actually changed hands.

How to read VWAP:

vwap above = pay more than most people. If the price exceeds VWAP, most people are paying more than what they paid today (weighted by the amount they bought). This means:

• Many people are buying it now and are increasing the price
• You may be purchasing when the price is temporarily high
• Prices may return to where most people bought it

Below vwap = get better deals. If the price is below VWAP, most people get a better price than what they paid today. This often means:

• More people sell it than they buy, pushing prices down
• You may have gotten quite a deal compared to previous buyers
• Prices may bounce back to where most people bought it

VWAP = Pay average. When a price is traded on VWAP, the average person pays exactly what he pays today, based on all the buy and sell that occurred.

Large traders use VWAP to benchmark trading. This is why VWAP often acts as support or resistance. Institutional algorithms are programmed to protect these levels.

Actual example: Bitfinex’s BTC/USD

• price: $118,940
• VWAP: $118,502

Bitcoin trades for around $438, beyond VWAP. Mild Premium region.

Transactions above VWAP typically show bullish momentum. This means that the average buyer for this session is profitable. This is a strong indicator that demand is currently outweighing supply. However, premiums are not over-excessive, suggesting that movement is still measured rather than euphoric. Several dynamics may be at work:

• Buyers are in controlbut not aggressive. It is a sign of healthy and stable accumulation.
• VWAP may act as dynamic support. If prices recede, the VWAP line could be around $118,502, at a level where buyers would recede.
• There is no clear discount It exists at this point. Traders looking for bargain entries are advised to wait for a potential retest of VWAP.

in short, Bitcoin is currently in a balanced but bullish positionand traders may want to see how prices behave around VWAP and measure whether this move has more legs or is time for breath.

VWAP + Other Indicators: Power Combo

VWAP works even better when combined with other tools.

VWAP + RSI:If the price exceeds VWAP and The RSI shows what was forced to buy. This is a powerful signal you might buy at a temporary peak.

VWAP + Volume: As prices increase volume and approach VWAP, they often show significant levels. Large players may be defending or testing this “fair value” line.

VWAP + Support/Resistance: VWAP often acts as dynamic support for uptrends and resistance for downtrends. It’s like a moving floor or ceiling based on where the actual transaction took place.

Looking at the example of BTC, if the price below the VWAP is $111,080 vs. $111,321 and a strong purchase amount appears as BTC approaches VWAP from below, it could show institutional interest in defending the “fair value” line.

Bonus Read: VWAP + RSI Power Combo

• price: $118,940
• VWAP: $118,502
• RSI: 66.11

This indicates that it contains bitcoin Bullish momentum However, they are approaching the territory they have acquired (RSIs above 70 are usually considered overbuying)

This setup is particularly interesting.

Although the technical indicators are clearly bullish, RSI’s proximity to acquired territory suggests that traders should pay attention to potential pullbacks or integration periods. A VWAP level of $118,502 could serve as a critical support zone if prices decide to retreat from the current level.

Overall, this combination of price action on VWAP and healthy RSI momentum creates a bullish environment for Bitcoin, but the over-conditions approaching suggest that upward movements need to be carefully monitored for signs of momentum fatigue.

Pro tips for using VWAP:

1. VWAP resets daily

Unlike moving averages, which look back on the set count period, VWAP is reset at the start of each trading day. This makes it ideal for day trading and short-term decisions.

2. Don’t fight strong VWAP trends

If prices consistently outperform VWAP with a strong volume, it is often a sign of authentic strength. The market says it is “willing to pay the premium price.”

3. VWAP Touch is golden

When prices drop and bounce to touch and VWAP, they are often a great entry point. The market is testing fair value and finding buyers.

4. Beware of VWAP breaks

If the price exceeds VWAP all day, if it suddenly breaks down with volume, it could indicate a change of emotion. The “fair value” line is violated.

5. Use multiple time frames

• Daily VWAP: Shows Big Picture Fair Value
• Hourly VWAP: Helps accurate entry/exit timing
• Weekly VWAP: Provides a long-term institutional perspective

VWAP Limitations: Things you need to know

VWAP is a powerful tool, but it is important to understand its limitations.

Volume Dependencies: VWAP needs healthy trading volumes to be meaningful. In low-capacity markets or outside of business hours, true fair value may not be accurately reflected.

Keeping behind: During extreme volatility, VWAP can keep up with price movements and may provide outdated information when you need it most.

Short-term focus: VWAP is reset every day and is primarily useful for intraday trading rather than long-term investment decisions.

Not predictive: VWAP shows what happened, not what happened. Don’t assume that prices always return to VWAP. Sometimes the breakouts are genuine and lasting.

Try it with Bitfinex:

• Log in to Bitfinex
• Please select a chart
• Add a VWAP from the indicator menu
• See how prices interact with the VWAP line
• Be aware of the relationship between volume and VWAP

Next, the chart decoder series: How to use Volume and Volume Check to see price action.

Bitfinex. Original Bitcoin exchange.

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Among the many available indicators, the VWAP indicator—or Volume Weighted Average Price—is particularly popular for day trading. By analyzing price movements, volume, and market trends, the VWAP can offer valuable insights into when to buy or sell. It’s a key tool that blends both price and volume, giving traders a clearer picture of an asset’s average trading price throughout the day.

In this guide, we’ll explore what the VWAP indicator is, how it works, and how you can leverage it effectively in your trading strategies.

What is the VWAP Indicator?

The VWAP indicator (Volume Weighted Average Price) is a popular trading tool used to measure the average price of an asset, factoring in both price and volume over a specific time frame, usually intraday. It differs from regular moving averages because it emphasizes the volume at each price level, offering a more nuanced view of the price action.

In Tradingview, you find the built-in VWAP when you search under indicators.

The VWAP resets every session (every day) on midnight, making it a great indicator for day traders looking to analyze intraday price movements. For the purposes of this article, we deactivated the “bands” on the indicator and we focus purely on the acutal VWAP.

How is VWAP Calculated?

To calculate VWAP, you take the total dollar amount of trades (price times volume) and divide it by the total volume. Essentially, it gives you the average price paid per share, adjusted for how many shares were traded at each price point.

VWAP = (Price x Volume) / Total Volume

Why is VWAP Important?

The VWAP indicator helps traders identify the average price of a stock or other asset over a specific period, taking both price and volume into account. This makes it a highly effective tool for identifying value, particularly in intraday trading. It’s a reliable way for traders to see if they are buying or selling at favorable prices compared to the market’s average.

How the VWAP Indicator Works in Trading

The VWAP indicator in trading integrates two critical elements: price and volume. By weighing the price by volume, it offers a more detailed picture of market sentiment. Here’s a key principle to remember:

• When the price is above VWAP, it’s considered bullish, indicating that the market is trending upwards and traders are willing to pay above the average price.

• When the price is below VWAP, it’s viewed as bearish, showing that the asset is trading below its average price, and the market may be in a downward trend.

At the beginning of a new day (midnight) the VWAP resets. Early in the day, you see that the price is trading around VWAP. An early day breakaway from the VWAP is common and it is important to analyze if the breakaway succeeds or fails. In the example below, the initial breakaway lower fails which puts the odds in the favor of a bull market. 

Going forward, VWAP pullbacks and retests can then be used to identify entry signals.

VWAP vs. Moving Averages: Key Differences

While both VWAP and moving averages (like SMA and EMA) are used to analyze price trends, they have significant differences.

Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) are calculated purely based on price and are commonly used to smooth price data over a set period. However, they do not account for volume, which can be a key driver of price action.

VWAP vs. Moving Average: When to Use Each

The VWAP indicator is especially valuable for intraday traders since it resets daily and incorporates volume, making it a more accurate reflection of market sentiment within that day. On the other hand, moving averages are more useful for identifying longer-term trends.

• Use VWAP for short-term, intraday strategies to find the average price adjusted for volume.

• Use moving averages for trend analysis over longer periods, where volume data is less critical.

In the scenario below, the daily 30 EMA (black line) provides the long-term trend direction. And because the price is trading above the daily 30 EMA, traders only look for long signals and ignore all short signals.

The VWAP can then be used to find long intraday signals into the long-term trend direction. All bearish VWAP signals below the VWAP are ignored.

Why Do Professional Traders Use VWAP?

Professional traders frequently rely on VWAP to assess whether they are executing trades at a favorable price compared to the rest of the market. It serves as a price benchmark that ensures large trades do not significantly influence market prices.

Retail traders can use VWAP similarly to monitor market activity and gain a sense of whether they are buying or selling at a favorable price relative to institutional activity.

Common VWAP Trading Strategies

There are several popular VWAP trading strategies that traders can implement to take advantage of price trends.

Breakout Trading

A breakout strategy using VWAP involves waiting for the price to move significantly above or below the VWAP line. For instance, if the price crosses above VWAP with increasing volume, it could signal a bullish breakout.

In the scenario below, the price traded inside a narrow triangle pattern just above the VWAP. The strong breakout candle then provided a potential entry signal as price was breaking away strongly from the VWAP.

Pullback Strategy

In a pullback strategy, traders look for price retracements back to the VWAP line after a strong move. For example, after the price rallies above VWAP, a pullback to the VWAP level could present a buying opportunity, assuming the upward trend continues.

The price is in an initial uptrend trading above the VWAP. The pullback into the VWAP was successful because the VWAP held as support level and the price was never able to close below the VWAP. The strong bullish candle away from the VWAP could have been a potential entry signal into the uptrend. 

Advantages of Using VWAP in Trading

There are several key advantages of VWAP that make it a favorite among day traders:

• Accurate Price Levels: VWAP provides more accurate price levels for entry and exit points because it factors in volume.

• Intraday Trading Efficiency: It improves efficiency for intraday trading, allowing traders to better time their trades.

• Price-Volume Correlation: VWAP integrates both price and volume, offering a fuller picture of the market’s real-time dynamics.

Conclusion

The VWAP indicator is an essential tool for both professional and retail traders, especially for those engaged in day trading. Its ability to combine price and volume into a single metric makes it invaluable for identifying market sentiment, potential entry points, and exit strategies. Whether you’re a beginner or a seasoned trader, incorporating VWAP into your trading strategy can offer a more informed and efficient approach to the markets.

To truly master VWAP, test out its use in different market conditions, refine your strategies, and continually adapt as you grow in experience.

FAQs on VWAP in Trading

What time frame is best for using VWAP?

VWAP is most effective on intraday charts, as it resets daily and is designed for short-term trading.

If you are looking for longer-term approach, you can change the anchor period to weekly which makes the VWAP at the beginning of a new week.

Can VWAP be used for long-term trading?

While VWAP is primarily a day-trading tool, it can offer value in longer-term trading when used alongside other indicators. However, its effectiveness diminishes the longer the time frame.

How does VWAP perform in low-volume markets?

In low-volume markets, VWAP can be less reliable due to the lack of sufficient data, leading to distorted signals.

How do institutional traders use VWAP to their advantage?

Institutional traders use VWAP to execute large trades without significantly impacting market prices, ensuring they are getting an average price comparable to other traders.