VWAP in Forex Trading: The Ultimate Guide to Volume Weighted Average Price
If you have ever questioned how professional traders are able to make consistent decisions to be profitable, despite your challenges with timing your entries, you're not alone. The secret ingredient many institutional traders use is VWAP - or the Volume Weighted Average Price.
VWAP is simply a reference price, but arrives at that price using a fairly simple formula: price multiplied by volume, divided by total volume. To clarify, for example, if you are buying groceries and you want to know the actual average price you paid for a item that you bought different quantities of, you would not calculate that by taking the average price. You would weight each price based on how many you bought of each. VWAP does the same thing for currency prices.
Large institutions use VWAP as their benchmark, after the market opens. They utilize it as a comparison to see if they are getting fair value on their trades. For the retail trader, VWAP becomes the tool to gauge the strength of that trend, and enter at appropriate points.
VWAP History: Origins and Development
VWAP did not originate in the forex world. VWAP originated in the traditional stock markets, where institutional traders needed a way to measure how well they traded against a fair benchmark. Before VWAP, trader were hard-pressed to figure out whether they were over or under paying for a large block of shares traded.
The idea developed due to a practical necessity. Let’s say that you are a fund manager, purchasing, throughout the day, 100,000 shares of stock at varying prices. How can you know if you got a good price? Simple price averaging will not work; after all, you bought many more shares at some prices than at others. The solution? VWAP, or a volume-weighted price benchmark.
VWAP Basics: Understanding the Concept
In the forex world this has some power because volume is real commitment to money. If the EUR/USD is moving associated with high volume, large players are putting money to work. If the EUR/USD is moving associated with low volume, it could be market random noise or small retail orders.
Typically VWAP is calculated out at the beginning of each trading session so now you have a new reference point to consider. There are traders that use a VWAP for a week or a month, and longer time frame, but plan intraday VWAP is the most common for intraday active trading.
VWAP Math: Step By Step Calculation
Don't worry about needing to calculate VWAP yourself! Your trading platform does the math. Still, the awareness of how it is calculated certainly helps with interpreting the signals VWAP gives.
The beauty about this simple calculation is that it can be tracked cumulatively. With every new period the next number we are adding to either the price × volume in the numerator and volume in the denominator; it is like a running weighted average, just like we discussed above, that becomes increasingly stable.
VWAP for Trend Confirmation
This is where one of the main situational advantages of VWAP enters the "fray" on behalf of the trader as it gives insight into market sentiment as well as strength of trend in relation to the price compared to VWAP.
If price persists above VWAP, buyers are exhibiting bullish behavior. If the market currently values the asset above the average price based on volume spent, buyers want to pay more than what sells for most of the volume weighed in the session. On the other hand, if price persists below VWAP, sellers are exhibiting bearish pressure - sellers have already accepted pricing below the average price based on volume in the session.
Conclusion & Practical Advice
Start with major currency pairs during liquid trading sessions. Use daily VWAP for intraday decisions and weekly VWAP for the overall context of trend. Don't act on any of the VWAP signals unless you get volume confirmation and incorporate proper risk management along with VWAP analysis.
The best VWAP traders develop patience and discipline. They do not act on every trade signal they see. They wait and only trade their higher probability set-ups, where several aspects align. They know that VWAP is not meant to be a signal for inevitable profit; it is used to improve the odds.
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