In this article we’re going to explore how to combine the incredibly powerful Volume-Weighted Average Price (VWAP) indicator (only recently released as part of our Order Flow Volume & Delta suite) with some simple technical analysis to generate high probability trading ideas. For the accompanying tutorial video, please click here.
What Is VWAP?
The VWAP indicator is derived by applying the most well known concept of technical analysis, the moving average, to the theory of volume. It measures the average price weighted by volume.
VWAP is calculated by taking the Dollar value of all trading periods and then dividing by the total trading volume for the current day. The easiest way to measure VWAP is to use it as a simple moving average. Therefore, if price is above the VWAP, price is rising, but if price is below the VWAP, it suggests that price is falling. As we mentioned above, the VWAP can indicate where trends are developing in the market.
So when we combine this powerful tool with simple technical analysis such as trendlines and support & resistance we can quickly generate great top trading ideas.
Trendlines With VWAP
One of the most effective ways to employ this indicator is to use it as a filter for trading trendlines. Whilst trend following continues to demonstrate profitability time and time again, we as traders know that the devil is in the details and the actual mechanics of how to successfully enter a trend can prove a little more complex in practice than in theory.
One of the favoured way to enter technical trends is to draw trendlines on a chart and then seek to enter in the direction of the trend as price tests the trendline. Whilst this generally works, it is not without risks (the obvious one being that the trendline fails) and so applying a filter to this method of trading can really improve its success rate.
We can apply the VWAP to areas where price tests the trendline to confirm our anticipated response (continuation of the trend) and provide a clear entry point.
In this chart we can see that we have a nice clear uptrend in play as denoted by our upward trendline. We draw the trendline onto the chart marking the low and the second low and we then have a potential trade zone to monitor, in the way of a third touch of the trendline.
Zooming in on the trade area then.
We can see that price tests the trendline but fails to break higher immediately. We continue to test the trendline whilst VWAP stays negative so there is no trade. However shortly after breaking down through the trendline ( in a manner which might suggest the trend is about to fail) we then see price reverse and break up higher, crossing up through VWAP which turns green giving us our buy signal to join the trend.
We can pop our stop below the low made as price broke the trendline and as you can see, price rose significantly in-line with VWAP and depending on how you managed the trade, it went on to accrue several hundred pips!
But the power of the the VWAP extends far beyond the profitable trading opportunities it creates; it is also fantastic tool for keeping you out of losing trades and signalling false reactions.
In the chart above we can see NZDUSD makes a high, then makes a lower high giving us our trendline, where we anticipate selling a third touch. We can see that price makes the third touch and we get a nice reaction from the trendline, however, price doesn’t close below VWAP and instead reverses and trades up higher. Now, if we had simply been trading the touch of the trendline or indeed price action at the trendline, we would have lost on this trade, but VWAP let us know that this was not in fact a proper sell off and didn’t give us a sell signal, keeping us out of a losing trade.
So as you can see, VWAP is an incredibly powerful tool when combined with even the simplest of technical analysis, creating a wealth of high probability trading opportunity but also helping you to stay out of the losing trades.
We have only taken a very simple look at the VWAP indicator here and our Forex Trading Course goes into much greater depth and discusses advanced strategies using the indicator, the indicator is also included in the price of the course. For the accompanying tutorial video on VWAP, please click here.
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