VWAP, also known as Volume-Weighted Average Price, in simple terms is the average price of a security over an average period of time, weighted for the amount of shares traded over a specific period of time. Many traders, from institutional money managers to the average day trader, use the VWAP as a major benchmark for the overall order flow throughout the trading session. For institutional size traders, they use the VWAP to evaluate where the best possible entry price might be; for example if their entry is below or above the VWAP at the time. If you are buying shares, it is said to enter the market at a price below the VWAP for the best possible results. This is because many believe if you’re buying shares, you would be doing so in conjunction with volume.
The VWAP is also a great way to get a feel for how the volume is flowing into the market for that day or that week. One of the best ways to use this knowledge is to determine what type of market you are trading in; is it a trending market or a choppy one? Once you have answered this question you can now utilize the full potential of the VWAP. In a non-trending market (choppy) you might want to consider fading, or buying/selling if price is moving away from the VWAP. Whereas if the market is trending you want to consider buying the lows and selling the highs into the VWAP.
The next indicator or tool that I find useful in my trading is the V-ROC, also known as the Volume Rate-of-Change. The V-ROC is a great tool to help identify the cyclical movements of volume in the markets. If the V-ROC is a positive number that then the volume is changing at an increasing pace, where as if the V-ROC is a negative number, the volume in the market is changing at a decreasing pace. How is this figure calculated? Well, first you need to divide the volume change of the last X-periods (days, weeks, months) by the volume over the past X-periods ago; thus resulting in a percentage change of volume, over the past X-periods (days, weeks and/or months).
Many investors will use a period of 15-30 days to provide them with a relatively short-term idea of how volume is flowing in the market. This helps especially when trying to determine if a rally or a sell-off in price is actually legitimate. To do this watch the V-ROC and see if there is a divergence in the V-ROC and the actual price movement; if there is a divergence in the V-ROC and price that might show a reversal or sluggish price movement in the near future. Another way I use the V-ROC is when price is trading around a key level of support or resistance. The V-ROC, I have found is very useful when price is approaching a level of support or resistance because once price breaks through the line of support or resistance it helps to confirm the break-out with an increase in the V-ROC indicator.
I have to say both of these indicators were great additions to my shorter and longer-term trading, and also helped me with my overall interpretation of volume in the market. I hope these tools will help you guys as much as they have me. As always, follow those rules and best of luck trading.
School of Trade.