In a webinar hosted by NinjaTrader, we reviewed one of our most popular premium tools , the Volume Weighted Average Price. Specifically, we looked at how this price benchmark can be used in multiple timeframes. By anchoring the indicator to the daily, weekly and monthly open, one can define institutional price action zones. This in turn can be used to identify VWAP trading setups. To learn more, watch the webinar recording or continue reading below:
The Institutional Price Action Zone
There are two main reasons why the Volume Weighted Average Price (VWAP) is important for institutional traders: First, it is a price benchmark used to control execution cost. Institutional traders don’t want to move the markets as they enter large positions. Therefore, they seek to locate areas where the majority of the day’s, week’s or month’s transactions are likely to occur. Statistically, 70% of all transactions during the session will take place within one standard deviation of the VWAP. That is what we refer to as fair value. Therefore, institutional traders are looking to execute near the VWAP where they‘ll find plenty of supply / demand.
Second, the VWAP is a factor in performance reviews. Good execution can be objectively measured by standard deviations from the VWAP. That means that better execution than the VWAP will result in a higher bonus payout.
Current Session VWAP Value
Fair value refers to prices that are within one standard deviation of the VWAP. Because institutional traders generally execute in that area, setups that form there are more likely to move. Generally, in VWAP trading you look for retracements back towards the value area. These are directional setups, going from inside the value area towards the outer standard deviation bands.
Once prices move towards the outer standard deviation bands, institutional traders are likely to take a step back and we’re likely to see rebalancing. The areas signal overbought/oversold scenarios and you may use that to identify exit points for directional trades.
Our VWAP indicators also come with mid-standard deviation bands (0.5, 1.5, 2.5). Mid-bands are particularly useful for higher timeframe VWAP trading where the regular standard deviation bands are further apart. Throughout the higher timeframe sessions, it is not uncommon to see these levels work as dynamic support / resistance levels.
Prior VWAP Value
The indicators included in our premium suite also plot the prior value area high and low points. You may find some of the best short-term VWAP trading setups when prices move out of the prior session’s value area. If the market moves out of the prior value area we’re more likely to see a trending market. However, if the market trades out of the prior value and then fails to follow through, we may be looking at reversal scenario.
Finally, the indicators come with the option to plot the VWAP levels set 2 and 3 sessions ago. Prior VWAP levels are important key S/R levels. This is mainly due to the fact that large institutional positions will take days to fill. It is therefore easy to imagine how these levels can used as opportunities to get in or out of trades.
Anchored VWAPs: Daily, Weekly, Monthly and N-Monthly
The daily VWAP is anchored at the ETH, RTH or at a custom session starting point. The indicator then plots the volume weighted arithmetical mean of all transactions taking place during the daily session. Prices for every transaction are added and divided by the total contracts traded during that time.
The session start for higher timeframe VWAPs, i.e. for the week, month or a N-month period, is the first trading day of those sessions. The current week, month and N-month VWAP are therefore identical to the daily VWAP at the start of their sessions. For the weekly calculation, one should wait until the 2nd daily session in order for it to deliver meaningful information about the current week’s VWAP levels. Likewise, until the second week of the month, a monthly VWAP will render the same information as the current week VWAP. Therefore, in order to create a reading at the outset of these sessions we created the Rolling VWAP which calculates continually weekly / monthly / quarterly / yearly VWAPs.
The Rolling VWAP
Although higher timeframe VWAPs contain valuable trend, value and oversold/overbought information, they have a certain drawback. As mentioned above, they are anchored at the start of the week, month and N-month session. For the weekly calculation, one should therefore wait at least 2 days in order for it to deliver meaningful information. Likewise, until the second week of the month, a monthly VWAP will render the same information as the current week VWAP. In order to evaluate VWAP trading setups at the outset of these sessions we’ve therefore created a rolling VWAP. It can be set to continually calculate weekly, monthly and N-monthly VWAPs.
The Rolling VWAP is not anchored at the beginning of the weekly session. It rather takes data from the previous session, moving it forwards. By using a rolling period of 5 days, one can then create a moving weekly VWAP calculation and have an accurate reading at the outset of the week. By using a rolling period of 21 days, one can create a moving monthly VWAP calculation at the start of the month.
Entry Timing and Stop Loss
During the presentation we also had a look at how to identify VWAP trading setups using the Zerolag Oscillator. The Zerolag Oscillator identifies momentum and early trend retracements. Specifically, locates directional setups where there’s a trend change or short term over sold/bought scenario.
In a long scenario, the short term oversold is indicated by the plotting of white bars. If buyers are taking advantage of these short term lower prices, the Zerolag Oscillator will outline possible retracement entries. Key retracement signals plot with the letter K. They signal a trend continuation following the first retracement. Secondary retracements, preceding a key retracement, plot with the letter R. Finally, momentum signals plot with the letter M. They signal oscillator momentum crosses above/below the zeroline, breaking the recent consolidation high/low level.
In a short scenario, a short term overbought plot with yellow bars. If sellers are taking advantage of these short term higher prices, possible short retracement entries will appear. The stop loss for these setups are located just a few ticks below or above the setup bar or the signal bar whichever has the lowest low or the highest high. You may set the stop loss for momentum signals right below or above the signal bar. Alternatively, you may set it below the low / above the high of the prior consolidation area.
The Overnight Range and Profit Targets
As for identifying targets, we also looked at the overnight range because it defines most recent high/low levels. The night session range will set the tone for much of the collective reasoning and psychology in the markets. Therefore, price levels from the Asian and EU sessions will often work as important support /resistance levels during the US regular session. Accordingly, we can use these price points to identify targets.
Expansion bands from this range can also work as reliable profit targets and our premium Opening Range indicator can for example plot the 50%, 100% and 200% extensions. The 50% extension will then equal half the overnight range, the 100% extension the entire range and the 200% extension two times the overnight range.
You may use that in situations when a narrow overnight range cause the standard deviation bands to contract. In those scenarios, prices will move beyond the outer standard deviation bands fairly quickly. The overnight expansion bands however, will give a clear measure of how far the move might go.
Conclusion:
The above discussed features of the VWAP indicator can help identify price benchmarks that institutional traders use to define value, overbought / oversold and dynamic support resistance levels. We can then use the Zerolag Oscillator to time the entries around these levels and the Opening Range to define possible profit targets.
To register for a free trial of our VWAP trading tools, visit this link.
Finally, to view another presentation on using our indicators in multiple timeframes, visit this link.
