Most traders in financial markets to analyze the current market situation and build trading systems (TS) use tools of technical analysis.
The VWAP indicator will be useful for beginners and experienced traders. It is an analogue of the moving average in which the price is averaged on the basis of volumes traded during the specified time interval.
The line of VWAP is similar to a moving average in appearance – it filters market noise well and reacts to significant price chart changes with a lag. These properties have inspired the use of the tool in various strategies and trading systems as a means of filtering false signals and dynamic support/resistance line.
However, the similarities between VWAP and Moving Averages are only external. There are much more differences:
The VWAP indicator is based on the data of real volumes obtained at CME Globex (electronic trading platform of the Chicago Mercantile Exchange). The volumes of futures contracts of the corresponding currency pairs are chosen as the basis. Therefore, the tool shows a great sensitivity to sharp changes of the market situation, which might not be adequately reflected on the price chart.
The averaging by volumes makes sense only if the indicator has a reference point. Unlike MA that builds continuously, VWAP is calculated on certain time intervals – hour, day, week, month, trading session, a user-specified interval. As a result, gaps are observed on the chart.
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The type of averaging used influences the chart lag. If at the moving averages it is constant and determined by period of MA, at the indicator VWAP, for which the data from the beginning of period to the current bar is used, the lag constantly increases (similar to the increase of period of moving by 1 with every candle).
The implementation of the indicator allows you to build a series of multiple timeframes on a single price chart, which simplifies the end-to-end analysis of the market situation (for similar actions with moves it is necessary to use non-standard multi-timeframe implementations).
The behavior of VWAP corresponds to the general properties of trend indicators and determines its application, similar to the tools of technical analysis from this category.
The advantages of the VWAP indicator include:
- consideration in the construction of the trading volume line, due to which the indicator reflects the market sentiment more accurately than the moving averages;
- high market noise filtering ratio due to cumulative calculation methodology, which allows to use the indicator successfully on low timeframes;
- sensitivity to significant price changes, which determines the universality of application in TS;
- the possibility of using it in HFT for trading strategies not only by prices, but also by volumes.
- the availability of the analysis of the series of current and older timeframes, which expands the possibilities of analytical and trading systems.
This list of strengths determines the increasing interest of analysts and market players in the use of the tool, especially in strategies based on the combined analysis of the price chart and volumes.
At the same time, VWAP has some disadvantages:
- The lag common for all averaging algorithms is characteristic of the indicator. Moreover, the lag increases together with the distance from the starting point of the current series, (similar to the growth of calculation period by 1 with each bar of the chart). This decreases the accuracy, sensitivity and the predictive value of the indicator on the interval, close to the end of the current series. However, at this moment the data accumulation has a positive effect – the resulting indicators of market interest serve as a guideline for the next calculation periods.
- The calculation principle dictates the use of volumes. However it is impossible to receive real volumes for every moment of trades on the over-the-counter market. Accordingly, in all implementations of the indicator the representation of volumes is formed on the basis of the data received in the trading platform. The data on the Globex futures contracts or the volumes of real transactions on a particular trading platform reflect the real values only approximately. The most critical attitude should be to non-commercial realization of indicators – the tick volumes of brokers have little in common with the true picture of the market.
In spite of these “disadvantages”, the VWAP indicator has proven its usefulness in strategy and TS.
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The use of VWAP is determined by its properties – its sensitivity to price changes, the participation of volumes in the calculations, the accumulative algorithm and the ability to sift the market noise. This versatility of the tool has become a basis for its application in medium- and long-term trading strategies and TS, day trading and HFT, technical market analysis.
The main area of application is dynamic support/resistance lines and trend identification.
The volume-weighted average price is considered a reliable reflection of buyers and sellers interest in a financial instrument. Accordingly, the VWAP indicator represents the equilibrium line of these interests.
This interpretation allows us to find out the prevalence of one of the forces on the market – if the price is above the line, the determining factor is the buyer’s influence, below – sellers. In this case, the distance from the current price to the chart of the instrument, the stronger is the pressure of the corresponding group of market participants.
At the same time the direction of the line reflects the prevailing trend.
Thus, VWAP is an indicator of trend and at the same time it is a dynamic support/resistance line. It allows the use of the tool in two types of strategies – trend and counter-trend (return).
In the first case, when the price is above VWAP, the options of buying the asset are considered, while below – selling. The second one formulates the opposite rules – in the area above the indicator line the sell signals are considered, below it – the long position opening.
The strategy choice is determined by various factors – the price impulse direction, the market being in a certain phase, the price proximity to significant levels, etc. Accordingly. It is quite difficult to build a TS based only on VWAP data.
How to set VWAP in your Tradingview