It’s a trade that works in any time-frame and can be a very high probability trade with low risk / reward parameters, when the set-up is followed. A rally to the +2SD, and a break to the -2SD, falls under price exhaustion patterns and signals that the market is ready to reverse.
Ironically, range days, which offer the least amount of trading opportunity from a P&L standpoint, offer the most opportunities for trade frequency with this set-up, due to the market’s proclivity on these days, for trading out to the SDs, and subsequently returning to the VWAP.
The flatter the VWAP (more horizontal), the higher the probability associated with the trade. In this case, the market is going sideways, so you can buy weakness and sell strength, and trade with a fairly tight stop. Stops are a discretionary choice, that can range from a few ticks, to the next SD.
If there is a positive or negative slope to the VWAP, the market may climb up, (red diamonds) or creep down the SD line, making it difficult to limit your risk with your stop. In this case, it is better to initiate your trades in the direction of the sloping VWAP, i.e., buying weakness with a positive sloping VWAP, (yellow arrow) and selling strength, with a negative sloping VWAP.
Deciding when to initiate the trade is the easy part, of course. It’s when the market tests the +2SD or the -2SD, however, it is important to have an idea of where you will exit the trade. You must always have some kind of money management plan in place when trading.
The trade should develop quickly, due to the nature, of this type of trade. You can take partial profits when the market pulls back to the VWAP, and if you want to squeeze the balance, you can get out of the rest and flip, when the market gets to the opposite 2SD.
If you trade in this manner, you can expect an extremely high percentage of winning trades. I take this trade every time I see it.
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Yes, the chart makes me cry. Below I have added the session VWAP for ES. The blue zone is the area between the 2SD and 3SD bands. which indicates an overbought or oversold condition. The orange line is the prior day's VWAP.
The picture is typical for a rangebound situation. The overall sentiment is bullish as price is above yesterday's VWAP. Price just retraces gently back to value during the night session. Under these bullish conditions you want to buy the lower 2-SD band near value (orange line).
There were few occasions to short during the night session as price never really reached the upper resistance area nor the upper 2SD band. The first opportunity came about 75 minutes into the regular session, when price broke above the previous established value area.
Now the bullish scenario was confirmed and you could either short the upper 2 SD band or buy the VWAP, which was possible at two occasions, when reversal bars were formed.
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But I was just saying the same thing. I think it is a simple and robust approach to make profits, as long
- as you do not use it against the trend
- you are willing and able to keep your stops, just in case that there is no mean reversion
Let us look at today's night session. Tuesday's VWAP (orange) is higher than Monday's VWAP (magenta). During the early morning hours price was sitting in the value zone between the two VWAPs. With the European session approaching price move up a little bit, touching the upper boarder.
Shorting the 2SD band worked prior to the European (Frankfurt) Open worked. But when volatility picked up after one hour into the session, it would not have been a good idea to engage in a mean reversion trade AGAINST THE TREND, when the 2SD band was hit.
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