If you're trying to get an edge in stock trading, it's useful to know what the big hedge funds and brokerages are doing. This allows you to trade with the big institutions instead of against them.
In order to this, one of the best indicators you can use is volume-weighted average price or “VWAP” for short.
So here's how to use VWAP to get an edge in stock trading.
What is the VWAP stock-trading indicator?
The VWAP indicator is a lot like a moving average. It computes the average price over time. But unlike a plain, old moving average, it is weighted based on the volume of trading done at each price point. So if a lot of people are buying and selling a share at a particular price, it will tell you this information.
A lot of hedge funds and brokerages tell their traders to try to fill orders at the VWAP price. So these traders are judged by their bosses based on how close they can hit this target. As a result, you can get a pretty good idea which way they are going to push the price by watching the VWAP indicator.
VWAP on particular time frames.
The VWAP indicator does not work on the daily charts or above. This is because of the way that it's calculated. In addition, this indicator is less useful on longer time frames than it is on shorter ones because the candles tend to only depart from the VWAP line on shorter time-frames.
So if you like to scalp or day-trade, this is the indicator for you.
How to use this indicator.
VWAP shows up as a horizontal line that moves across the screen as the price progresses. When the price is above this line, it means that the price is currently above it's average weighted by volume. This means that institutions are likely trying to fill sell orders.
When the price is below this line, it means the price is below its average weighted by volume. In this case, institutions are likely trying to fill buy orders.
The best way to use this indicator is to look for short entries when the price is above VWAP and look for long entries when the price is below VWAP.
But you want to use candlesticks as a confirming indicator. If you see a bullish candlestick pattern while looking for longs, then you enter the trade. If you see a bearish candlestick pattern while looking for shorts, then you enter the trade.
Here's an example using the SPDR Gold Trust (GLD).
I've labeled three candlestick patterns on this chart. The first one is a shooting star while price is above the VWAP.
The second is an ambiguous pattern above VWAP. But this red candle has a long upper-wick, and it occurred right after a big move up. So it could be interpreted as a very weird looking shooting star.
The third one is a hammer while price was below VWAP.
Each of these candles signaled that the price was about to revert to VWAP. And that's exactly what it did.
If you're tired of trading against the big institutions, use VWAP to put yourself on the right side of your trades.