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Assume that over a period of 1 min 3 trades have printed,
-> first trade 1 contract at 100.0
-> second trade 5 contracts at 101.0
-> third trade 3 contracts at 99.0
The volume weighted average price for our 1-minute period is
(1 * 100.0 + 5 * 101.0 + 3 * 99.0) / 9 = 100.22
Anchor point
Unlike its brother, the VWMA (volume-weighted average price) the VWAP has an anchor point.
VWAP: volume-weighted average price of all trades that occured after the anchor point
VWMA: volume-weighted average price of all trades that lie within a moving window of N bars
The anchor point selected for a daily VWAP is typically the start of the trading day. The VWAP is displayed until the end of the trading day. This means that the VWAP gradually takes weight. You can considere it as a bag of coins which is empty in the morning and full in the end of the session. When it is empty a few heavy or extra-light coins can have a large impact on the average weight - the VWAP is still unstable. In the end of the trading day the average weight of the coins is not impacted by a few newcomers - it is stable.
The weekly VWAP is reset at the beginning of each week, the monthly VWAP is reset at the beginning of each month.
Benchmark
The daily VWAP is basically the price of the day. If you look at all contracts traded and want to find the average price, that is exactly the VWAP.
If a large investor hands over a buy order to a broker, he expects that the broker will be able to handle the order for a price equal or lower than the average price (VWAP) of the day. Therefore the broker will try to purchase on behalf of his client, when the price is below VWAP, or on an uptrending day, when it retraces to VWAP. Brokers and investors use different algorithms for executing large orders. Many of these algorithms use the VWAP as a benchmark.
The VWAP can also be used as a trend indication. When today's VWAP is higher than yesterday's VWAP, this means that traders were paying a higher price today then yesterday. The trend is up!
The chart below shows CL 02-14. CL has been in an established downtrend and saw a smaller move up on Friday. Thursday's value area low has not been tested. However there was a strong rejection, when Wednesday's prices were tested.
Standard deviation bands
Standard deviation bands from the VWAP can be used to determine when there is an overbought (above upper 2SD band) or oversold (below lower 2SD band) situation.
One shouldn't take trades off VWAP except in trending situations. Otherwise it's "the middle" .... the congestion that people need to stay out of.
Most definitely. I love pairing VWAP and Volume Profile. Wouldn't trade without them. They can help you determine if price has unfairly moved away from value, particularly on an intraday level.
Good stuff by @Fat Tails. I too have charts on with SD of daily VWAP. Also keep an eye out for 2day and Weekly VWAP. I find it useful to have plots of the above. It is amazing to see price respect or break this near PRZs. VWAP defines a range for me. Along with a keltner it can be used for trend days or trends...so keltner is what gives me trend.
Thanks liorzuk - your question is one for the homework and statistics thread here...
I will dig deeper and try to find an answer as I haven't any statistic yet
I applied on sierra charts and looks interesting. I heard about it from a client. Not sure yet how to use it but here is how it looks like on my chart:
Again, it's a compass. On identified "range" days, you should be looking to place your trade at the extremes (low or high) with the target of VWAP in mind. If you sit and watch, you see that on range days the distance between the low/VWAP or High/VWAP are typically near equidistant.
On identified trend days, you should attempt to use VWAP as an entry when price pulls back. At the open of the regular session, trend days typically happen fairly quickly due to the nature of the on-open market orders firing off and the wide spreads (well at least in equities), so that's why waiting for that quick pullback to VWAP can be beneficial.
Seriously, go back and look at charts and how price responds to VWAP on a range days vs. a trend. You'll see the things I speak of.
It's not always easy to know if we're looking at an upcoming range or trend day. So obviously we do other analysis like the volume profile. VWAP isn't the only "benchmark" price on the day either, as there is also the POC (point of control). But by contrasting the two you can identify a particular "skew" to take advantage of.
