Before technical analysis and the Dow theory, stock trading involved reading economic data, monitoring company performance, and analyzing market price trends without digital trading charts or technical indicators. While fundamentally different in practice, trading today relies on the same foundation.

Traders need to understand the market and be able to spot market trends easily to make profitable trades. However, the trading process is significantly easier today with the help of technical indicators that highlight price and volume markers that suggest the possible profitability of a single trade. One example is the Volume-Weighted Average Price indicator.

History of the VWAP Indicator

Kyle Krehbiel developed the Volume-Weighted Average Price Indicator, introduced to the trading world in the 1980s. The tool helps traders identify an asset’s market value by considering its price and volume.

The VWAP Indicator has since gained much popularity, and more variations of the tool, such as the Anchored VWAP, have been developed to introduce new insights into market dynamics.

What is the VWAP Indicator?

Also known as the Volume-Weighted Average Price Indicator, it is a technical analysis indicator that provides insight into a cryptocurrency’s price trend and true value. The volume-weighted average price indicator considers two main factors: cumulative volume and cumulative typical price.

Like other average price technical indicators, the primary purpose of the VWAP indicator is to highlight the average price of the specific asset. However, it also considers the asset’s trading volume to provide a comprehensive view of the market sentiment and price trajectory.

How to Calculate the VWAP Indicator

Like most indicators, the VWAP indicator should typically be built into a computerised trading chart. Nevertheless, it is useful to understand how to calculate it when it is not provided on your trading chart.

The volume-weighted average price is calculated for one trading day. The trading chart and values for calculating start at market opening and end at the close of the market for the trading day. This means that the values used for your VWAP should be derived from a day’s trading chart.

To calculate the Volume Weighted Average Price, you need three things;

• Cumulative typical price: This is the average price of the coin for the entire trading session. To get the cumulative typical price, you need to add together the highest price, lowest price, and closing price for the period and divide them all by 3. The formula is presented thus: [(H+L+C)/3].
• Volume: This is simply the total volume of trades for that period,
• Cumulative volume: This is the running total of the daily volume.

Now that you have your values, the formula for the volume-weighted average price goes like this:

Now that you have your formula, follow these steps to calculate your volume-weighted average price.

1. First, find the average price the coin was traded for over the first 15 minutes of the day. You can get the average price by adding the high, low, and close and dividing by 3.
2. Next, multiply your average price by the volume for the same period. Record your final PV in a notepad or spreadsheet.
3. The formula above divides the PV volume by the volume for that period to arrive at the volume-weighted average price.

NB: If you want to maintain the VWAP throughout the day, continue adding the PV value from each period to the subsequent numbers. Then, divide the total sum by the total volume traded up until the end of your selected period.

Manually calculating the VWAP might be easier if you keep track of your records in a spreadsheet with columns indicating the cumulative pv and cumulative volume.

Function of the VWAP Indicator

Like other technical indicators, the VWAP line is instrumental in indicating specific market trends. By analysing the position of the VWAP line in relation to the position of the price ticks, the trader is able to ascertain whether an asset’s price trend is bearish or bullish.

Generally, when the price of the asset is above the line, it means the coin is selling at a higher price than the volume average weighted price, suggesting an uptrend.

Where the case is reverse and the price falls below the average, it implies a downtrend signal by the asset being sold at a lower price than its average.

The VWAP line can be used by traders to identify overbought and oversold conditions in the market, thus helping them make better-informed trading decisions. An overbought signal occurs when the price occurs above the VWAP line, while the price appears below if the token is considered oversold. Using knowledge of these signals and the market, traders can make predictive trades to avoid the fallout from corrective trends in the foreseeable future.

The VWAP line also functions as a support or resistance level. By analyzing the line’s curve, traders can determine how strong or weak an existing price trend is and how likely it is to be reversed.When the coin’s price reacts to the VWAP line from below, it is considered a support level; in the inverse case, it is known as a resistance level.

How to Trade Using the VWAP Indicator?

Even with a technical indicator as reliable as the VWAP indicator, there is no one successful strategy for trading. The cryptocurrency market is unique and often characterized by price instability and volatility. Therefore, it requires using unique trading strategies, often involving technical indicators and strong trading strategies. Some trading strategies best used with the VWAP Indicator include:

VWAP Bands and Channels

The VWAP indicator includes upper and lower band lines. Both these lines can be used to identify buy and sell signals. A buy signal occurs when the price rebounds inside the channel (between the upper and lower bands). If the price falls above the upper band, it is typically considered an overbought condition, and where it is the reverse, it is known as an oversold condition.

A trader can rely on the VWAP indicator’s bands and channels to identify possible profitable trading opportunities and make prepared decisions about where to enter buy or sell orders.

Breakout Trading Strategy

In trading strategies, a breakout occurs when an asset leaves the support or resistance level with coordinating increased volume. A popular strategy that leverages this change in the market relies on being able to spot the early stages of a price trend and making profitable trades.

As mentioned earlier, the VWAP indicator can function as a resistance level, indicating a possible upward trend in the price of an asset where the VWAP line crosses over the price. Therefore, a trader using the breakout strategy could benefit from implementing the VWAP technical indicator line as a support or resistance level to indicate where to make buy or sell orders in response to market changes.

Retracement and Reversals Trading

Retracement trading works by analyzing a token’s price chart to identify temporary price reversals and entering the market during those short price reversal trends.A trader employing retracement trading can use the VWAP indicator to spot temporary pullbacks in the price trend and then enter trades at the right time.

Should You Use a VWAP Indicator With Other Technical Indicators?

While the VWAP indicator is a valuable tool for understanding market trends and price averages, it’s not advisable to rely solely on it as your entire trading strategy. The technical indicator can tell you the price of an asset moves relative to its average, but it does not consider the strength of the price trend, the volatility of the asset, or market sentiment and momentum. Therefore, combining the VWAP with other technical indicators is the more likely profitable option.

Different indicators offer unique perspectives—some track momentum, while others assess trend reversals or price volatility. Below are three indicators that complement the VWAP and enhance its effectiveness in crypto trading:

Relative Strength Index (RSI)

The RSI measures the momentum of price movements, helping to identify whether a cryptocurrency is overbought or oversold. When paired with VWAP, the RSI helps traders confirm market conditions. For example, if a coin’s price is above the VWAP line, indicating an uptrend, but the RSI shows overbought levels, it suggests the price could be due for a pullback or correction. This combination allows traders to validate the trend while watching for potential reversals.

Moving Average Convergence Divergence (MACD)

The MACD is a popular trend-following indicator that reveals changes in momentum. When used with the VWAP, the MACD helps confirm the strength of a trend. If the price is above the VWAP, and the MACD shows a bullish crossover (when the MACD line crosses above the signal line), it confirms that the uptrend is gaining momentum. Conversely, if the price is below the VWAP and the MACD shows a bearish crossover, it suggests that the downtrend may continue. The MACD’s ability to indicate momentum shifts makes it a useful companion to the VWAP for timing entry and exit points.

Bollinger Bands

Bollinger Bands measures market volatility and identifies potential breakout or retracement opportunities. When combined with the VWAP, they help confirm whether a price move will likely be sustained or temporary. If the price breaks above the VWAP and also breaches the upper Bollinger Band, it signals a potential breakout. On the other hand, if the price stays within the Bollinger Bands but hovers near the VWAP line, it might indicate a stable market or a potential retracement. The combination of VWAP and Bollinger Bands allows traders to assess both price levels and market volatility, improving their ability to anticipate trend reversals.

Conclusion

The Volume Weighted Average Price (VWAP) is a valuable technical indicator that provides traders with insights into market trends and price averages. By understanding how to calculate and interpret the VWAP, traders can make more informed decisions about buying and selling cryptocurrencies. While the VWAP can be a powerful tool, combining it with other indicators can provide a more comprehensive market view and enhance trading strategies.