Updated: Oct 17, 2021
In this blog post, we will introduce one of the TI based on volume that we believe will add value to your trading performance. Some of the benefits of using this indicator for intraday trading are as follows:
being on the right side of the daily trend;
avoiding late entries;
great risk:reward ratio;
clearly defined stop-loss areas
Why VWAP must be used by all intraday traders no matter the market they trade?
VWAP stands for Volume Weighted Average Price and it is highly used as a benchmark by professional traders and institutional funds to liquidate or accumulate positions. Therefore, we always want to trade with the "smart money" and try to avoid randomness in our trading. The VWAP looks like a moving average on a chart but it is fully based on the volume of that security. To us, volume is the key indicator to look for further clues in the market. Volume tells you where the market might be heading next if you are able to identify the accumulation or distribution points. For a further read on VWAP then read this post from Investopedia.com
The VWAP indicator can be found in most trading platforms or on tradinview.com charts. This is how it looks:
VWAP (session & weekly)
It is best to keep both VWAPs plotted on the same chart in order for you to always know how the market is reacting each day. Most of the times, you will be trading with the VWAP of the session and idea is to:
buy if price breaks & holds above VWAP;
sell if price breaks & holds below VWAP.
I trade mostly indices and Gold and sometimes FX pairs; VWAP works in all of them. The closer to the VWAP you are engaging, the better it is for your R:R ratio. The further down or up price is from VWAP the higher the chances the market will reverse back (standard deviation from VWAP is another useful add-on to the simple VWAP indicator, however we will leave it for the next time).
VWAP for the session: helps you determine the intraday trends;
VWAP for the week: helps you determine the trend of the week.
Let us look at some other VWAP examples and trading setups
Gold spot 5 minute chart
On Friday morning until news release, Gold was stalling and trading near the HOD (high-of-day) and holding above the VWAP but without strong conviction. Buyers seemed to have lost their momentum and traders were looking for clues whether we would have pullback after the massive rally in the prior day or not. We were tracking VWAP at 1717.5 as a signal to enter the market. The way we trade with VWAP is in two steps:
wait for the breakout;
enter on the pullback/bounce to pre-breakout area.
On the following chart, you can see that breakout happened below VWAP at point "1" then market bounced and retested VWAP at point "2" and failed to consolidate above VWAP. As such, for the remaining of the day, Gold traded lower and retested VWAP and closed below that support. If you had shorted around point "2" or even a bit later, the trade would have hit your target at VWAP weekly. Not all setups are are perfect, nevertheless, once you catch a good trade, you are guaranteed a R:R of at least 1:3 which means one good trade can make up 3 prior losers you had.
E-Mini SP500/SPX 5 minute chart
The best markets where VWAP played out near to text-book were the US indices, such as SPX, Dow, Nasdaq.
GBPUSD 5 minute chart
GBPUSD wasn't an easy market to have traded last Thursday and Friday and this shows how important it is for all traders to perform a Top-Down Approach to their analysis. Only once you have understood the big picture and the higher-timeframe pattern, you will be able to reason with the intraday price swings.
USDCAD 5 minute chart
This is how weakness looks in a market based on volume. If you had been buying on Friday on USDCAD just because it was too low then you probably had a tough day. A few attempts to cross over VWAP but without conviction and consolidation above.
To summarize, keep in mind the following:
Trade intraday only once you have understood the larger timeframe pattern;
Use VWAP levels to determine who has control for the session or week (bulls vs. bears);
Follow the 2-step process in executing near VWAP (breakout-retest-enter);
The further away from the VWAP we are, the higher the chances for a reversal back to or near VWAP;
Try to trade markets that have high volume, a catalyst or a reason to move considerably for the day. Avoid ranges and slow moving markets.
In this new post, we discuss about standard deviation of VWAP and how to trade with Developing Value Areas. If you want to upgrade your trading to a more professional and institutional approach then VWAP DVA is your answer.
You might want to read up on the following concepts as well:
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Until next time, be a mindful trader.