The Volume Weighted Average Price (VWAP) is a valuable technical analysis tool, particularly suited for day traders and intraday traders in the fast-paced cryptocurrency market. Its precision in identifying entry and exit points within short-term timeframes makes it a preferred choice among traders looking to capitalize on the volatile nature of cryptocurrencies. In this article, we'll delve into the essence of VWAP trading and how it serves as a foundation for crafting successful crypto trading strategies.

 

 

Understanding Volume Weighted Average Price (VWAP)

The Volume Weighted Average Price (VWAP) is a crucial tool that day traders employ to assess the relationship between price and trading volume, aiding in the identification of overbought and oversold market conditions. VWAP is instrumental in guiding traders when to initiate or liquidate positions in both stock and cryptocurrency markets. When interpreted correctly, it enables traders to make well-timed market entries based on its comparative value with previous trades, as well as recognize instances where asset price movements have accelerated too swiftly, prompting consideration of exiting positions.

 

Using VWAP to Anticipate Market Trends

To grasp the utility of VWAP, it's essential to comprehend how the indicator's calculations are performed.

 

First and foremost, the VWAP line is reset at the start of each trading day, catering specifically to the needs of day traders who operate within this timeframe. The calculation begins with the determination of the typical price, which is an average derived from the high, low, and close prices of the candle timeframe:

 

Typical Price = (High + Low + Close) / 3

 

Unlike most charts and indicators that rely on the closing price of the candle, VWAP utilizes an average of the high, low, and close values for each period, resulting in a more accurate representation of the asset's true price during that time frame. This approach proves invaluable when the market undergoes reversals, as it equips traders with insights into present and future trends, facilitating informed decision-making.

 

Deriving the VWAP Line Using Typical Price

To construct the VWAP line, the process involves working with the typical price and trading volume data. Here's a breakdown of how it's done:

 

1. Typical Price Calculation:

To begin, the typical price is determined, which is computed as the average of the high, low, and close prices for the given timeframe. Mathematically, it is expressed as:

   

   Typical Price = (High + Low + Close) / 3

 

2. Subtotal for the Current Time Frame:

Next, the typical price (TP) is multiplied by the trading volume (V) associated with that specific time frame. This results in a subtotal for that period, denoted as TP*V. If you're working with 15-minute candlestick charts, this calculation represents the product of the typical price and the trading volume for that 15-minute interval.

 

3. Cumulative TP*V Calculation:

Subsequently, each successive 15-minute calculation is added to the subtotal, cumulatively accumulating the TP*V values for the entire trading day. This process leads to the creation of a cumulative TP*V value.

 

4. VWAP Calculation:

The final step involves calculating the VWAP by determining the ratio of the cumulative TP*V to the cumulative trading volume. Mathematically, it is expressed as:

   

   VWAP = Cumulative [TP * V] / Cumulative Volume

 

The outcome of this computation results in a VWAP line, which dynamically traverses the price chart, typically in tandem with the cryptocurrency's price movements.

 

Fortunately, you need not perform these calculations manually, as computer charting software automates the process, seamlessly plotting the VWAP line onto your price chart for your convenience.

Utilizing VWAP to Identify Overbought and Oversold Conditions:

The Volume Weighted Average Price (VWAP) serves as a valuable tool for assessing overbought and oversold levels in the market. It calculates an average price that takes trading volume into account, providing a genuine representation of price levels.

 

1. Overbought Condition:

When the market price surpasses the VWAP line, it is regarded as overpriced and overbought. Trading in the overbought zone means acquiring assets at a premium cost.

 

2. Oversold Opportunity:

Conversely, when the market price falls below the VWAP line, it signifies that the market is undervalued, potentially presenting a favorable buying opportunity. While it doesn't guarantee further price drops, purchasing in this zone offers relatively better value compared to buying during overpriced phases.

 

Which Chart is Most Effective for Detecting Trends Using VWAP?

VWAP primarily serves the needs of day traders, making it a valuable tool for those engaged in crypto day trading, where positions are typically held for less than a day.

 

Crypto day traders frequently utilize minute-based charts, including 1-minute, 3-minute, 5-minute, or 15-minute charts. These shorter timeframes, coupled with VWAP, enable day traders to visualize how trading volume influences the average price.

 

For markets traded on exchanges, such as cryptocurrencies and stock markets, VWAP is particularly well-suited due to the availability of accurate volume data. In contrast, the forex market, being traded over the counter, may lack precise volume figures. Consequently, the VWAP indicator may generate unreliable signals in the forex market.

Day Trading Strategies with Volume Weighted Average Price (VWAP)

Trading opportunities abound when using VWAP, but it's crucial to acknowledge that changing market conditions can affect these strategies positively or negatively.

 

For instance, day traders, known for their 24/7 trading activity, should be aware that VWAP continues to calculate even during weekends. However, weekend trading may not be the most opportune time, as significant trades can sway the market drastically.

 

Hence, these trading strategies are best suited for Monday through Friday when crypto markets typically experience higher volumes.

 

Trading Strategy 1: The Retracement Trade

This strategy adopts a more conservative approach, allowing the market to guide decision-making. It requires a 15-minute price chart for primary cryptocurrencies like Bitcoin or Ethereum and employs the VWAP indicator.

 

1. Market Bias: In the context of an uptrend, focus solely on identifying long positions.
2. Entry Point: Monitor the crypto market for a dip that results in a close below the VWAP, triggering a buy signal alert.
3. Confirmation: After a candle closes above the VWAP, initiate a long position at the opening of the subsequent candle.
4. Risk Management: Place the stop-loss just below the most recent swing low. This setup ensures that if the price corrects below the recent low, it must also breach the VWAP for validation.
5. Profit Target: Target a profit level at least twice the distance between the entry and stop-loss. For example, if the entry price is $32,129.50 and the stop loss is set $410 Bitcoin points below, aim for a profit target of $32,949.50.

 

Trading Strategy 2: VWAP Bands and Channels

This strategy, relatively more aggressive, involves seeking entry at improved and lower prices, potentially resulting in a higher number of losing trades.

 

1. Chart Setup: Employ a 5-minute candlestick chart that incorporates VWAP. Additionally, introduce VWAP bands set to two standard deviations above and below the VWAP line.
2. Market Bias: Exclusively focus on buy signals when the crypto market exhibits an uptrend.
3. Entry Criteria: Look for instances where the market reaches the lower band. Occasionally, the price may temporarily breach this lower boundary. If this occurs, wait for the price to return inside the channel by moving above the lower band.
4. Trade Initiation: Once the price is back within the channel, commence a long position. Set the stop-loss below a recent swing low on the chart.
5. Profit Target: Similar to the previous strategy, aim for a profit target set at twice the distance between the entry and stop-loss levels.

 

These VWAP-based day trading strategies offer valuable tools for navigating cryptocurrency markets effectively. However, traders should remain flexible, considering the potential impact of changing market conditions on these strategies.

VWAP vs. Moving VWAP: Understanding the Distinctions

While VWAP serves the purpose of recalculating its values daily, making it ideal for day traders, there's a need for a tool that offers a more comprehensive view of pricing trends. This is where the Moving VWAP (MVWAP) comes into play, acting as a moving average of the VWAP. Despite their shared foundation, these two indicators exhibit significant differences.

 

1. Timeframes: VWAP caters to the shorter-term preferences of day traders, whereas Moving VWAP can be effectively applied to longer-term chart intervals spanning days, weeks, or even months.
2. Calculation Continuity: VWAP provides a running total throughout a trading day, resetting at each day's close and starting anew at the next day's open. Conversely, Moving VWAP offers an average that persists indefinitely, accumulating values day after day.
3. Utility: While VWAP primarily signals overbought and oversold conditions based on volume, MVWAP can serve as the foundation for a moving average crossover strategy.

 

Effective Use of Technical Indicators Alongside Volume Weighted Average Price (VWAP)

VWAP acts as a valuable tool for gauging price levels of relative cheapness or expensiveness, but its accuracy can be enhanced when combined with complementary technical indicators. Here are a few such indicators:

 

1. Pivot Points: These were originally used by floor traders in pre-computer trading days to quickly determine potential reversal points in the market. Daily pivot points remain crucial for day traders as they indicate price-driven levels where market pivots and reverses.

 

2. VWAP and Trend Lines: Employing additional technical tools like trend lines can further assist traders. Trend lines provide insights into trend direction over several days, aiding in identifying potential pivot and reversal points in the trend.

 

Reliability of Volume Weighted Average Price (VWAP)

While VWAP can be a helpful tool for day traders, its reliability should be understood within the context of market conditions. Several factors can influence its accuracy:

 

1. Market Noise: VWAP uses volume in its calculations. In periods of extended weak volume, markets tend to trade within a range-bound, sideways pattern, potentially leading to less reliable signals from VWAP.
2. Trading Costs: Frequent trading can diminish profits due to spread costs incurred with each open position. Traders need to consider that immediate closing of positions for profit isn't possible, as market makers take a spread for facilitating the trade.

 

 

Conclusion

Volume Weighted Average Price (VWAP) is a valuable ally for crypto day traders, aiding in the assessment of average weighted prices. Many crypto trading strategies can be constructed around VWAP, often in conjunction with tools like channel bands, pivot points, and support and resistance levels. Nevertheless, VWAP's effectiveness can be influenced by market conditions, making it vital for traders to apply it judiciously.