Volume-Weighted Average Price (VWAP) Explained
Generally, when it comes to financial markets, there are trading technical indicators that help traders predict market behavior and, by default, guide their trading decisions. The rule of thumb is no trading chart should be created without some technical indicators to help a trader with their decision. The technical indicators for Crypto trading are in various forms. Among them are momentum and volume indicators that help determine price movement.
As a technical analysis tool, Volume Weighted Average Price (VWAP) is a volume indicator that helps traders spot exit and entry points in a given timeframe. Since cryptocurrencies are highly volatile and the crypto market operates 24/7, traders are constantly exploring several ways to maximize trading opportunities. Ultimately, VWAP trading helps traders determine the direction of asset prices and when to buy or sell. This guide will therefore explain in detail the concept of VWAP and how crypto traders can build their trading strategies around it.
What is VWAP?
VWAP (Volume-Weighted Average Price) is a technical trading indicator that determines the daily average price for cryptocurrencies. VWAP is one of the essential indicators to use when trading the crypto markets, as it enables traders to buy below the average price and sell above the average price.
This indicator is widely used in other markets to evaluate buy/sell spots but was recently employed in the crypto markets. In the stock market, for example, the trading closes at a specific time, and the indicator reset at the start of each day — providing a new weight based on the formula. However, since the crypto industry works around the clock, the indicator resets after the new daily candle starts.
Ultimately, VWAP is a measure of the average price at which an asset is traded over a given period, and the daily average cost is estimated by adding up the daily trading volume and dividing it by the total number of units traded.
For example, if Ethereum is trading at $2,000 and the price swings between $1,000 and $3,000 — the VWAP value will amount to $2,000 for the day.
How To Trade With The VWAP Indicator
To start trading with VWAP indicators to learn how it works, it’s essential to understand how the prices of VWAP are calculated. First, we need to determine the VWAP line at which it is reset each day. This gives traders accuracy and an overview of the daily VWAP values.
VWAP calculation
VWAP (average daily price) is the value gotten when the current price of an asset is multiplied by volume and then divided by volume. As the price of crypto constantly fluctuates, the VWAP value also changes over time.
VWAP = Cumulative [TP*V] / Cumulative Volume
Where:
- TP = Total Price
- V = Volume
What does VWAP tell Traders?
The VWAP shows the average pricing based on the amount of trading volume for that pricing level. Therefore, traders can view the VWAP line as a true average price.
- Overbought and Oversold Levels
Typically, if the asset price is above the VWAP line, then it is considered overvalued or overbought. On the other hand, if the pricing level is below the VWAP line, then the market is underpriced and might be a good buying opportunity.
- Spot Market Trends
In the same manner, VWAP can be used to spot the price direction simply by analyzing how the average
price reacts to the amount of volume being traded.
Wrapping Up
VWAP is an important tool for traders to gain the overview behavior of the market and determine when asset prices are overbought or oversold. However, using this indicator as a stand-alone metric isn’t reliable. It’s crucial to combine this indicator with other relevant indicators, such as support and resistance trendlines, etc., to make better and more informed trading decisions.
