Introduction to Volume Weighted Average Price (VWAP)
Average prices are key information that professional traders use in order to identify trend direction and probable key turning points. Moving averages can provide this information. However, the VWAP can be a better option as it also incorporates volume in its consideration of the average price.
What is VWAP?
Volume Weighted Average Price (VWAP) is a technical indicator used by traders to objectively identify the average price of stocks, indices, commodities, currency pairs or other tradeable securities while taking into consideration the volume traded on each period. It places more weight on candles representing periods traded with more volume giving traders insight on how the market values a tradeable security.
How the VWAP Indicator Works?
The VWAP computes for the typical price for the period, which is the average of the high, low, and close of the bar. It then multiplies the typical price with the volume for that period, which is called the PV. It then divides the result with the volume for that period, which would be the first point of the VWAP line.
The VWAP indicator then continues updating the VWAP line by repeating the process by summing up the PV and dividing the sum with the total volume. This creates a VWAP line which represents the average price with volume weighted on each bar.
This version of the VWAP display the daily, weekly, and monthly VWAP.
How to use the VWAP Indicator for MT5?
There are several ways to trade the VWAP.
One method is to trade mean reversals using the VWAP line as the target take profit exit point. Traders would anticipate potential reversals whenever price is oversold or overbought trading against the VWAP line then close the trade as price touches the VWAP line. However, this method would require another indicator to point out overbought and oversold price levels.
Another use would be as a trend direction bias filter. Here, traders would trade only in the direction indicated by the VWAP, taking only buy trades whenever price is above the VWAP and sell trades whenever price is below the VWAP.
The VWAP could also act as a dynamic support or resistance line especially on the lower time frames. Traders would take buy or sell trades anticipating that price would bounce off as it touches the VWAP line.
Buy Trade Setup
When to Enter?
Price action should generally be above the VWAP line. Wait for price to touch the VWAP line and show signs of price rejection. Enter a buy order as soon as the reversal candlestick pattern forms. Set the stop loss below the pattern.
When to Exit?
Close the trade as soon as price action shows signs of reversing back down.
Sell Trade Setup
When to Enter?
Price action should generally be below the VWAP line. Wait for price to touch the VWAP line and show signs of price rejection. Enter a sell order as soon as the reversal candlestick pattern forms. Set the stop loss above the pattern.
When to Exit?
Close the trade as soon as price action shows signs of reversing back down.
Conclusion
The VWAP is an effective trading tool to use when trading the lower timeframes especially on day trading strategies. It helps traders identify trend directions as well as key areas for probable mean reversals.
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