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How to trade with ATR (Average True Range)

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How To Trade With ATR
How To Trade With ATR

ATR (Average True Range) is one of the essential tools in my trading toolbox. It is not a holy grail, but it helps me to navigate the trading day and make trading decisions.

In this blog post, I want to go through details of the indicator and how I use them in my trading. Hopefully, it will help you to integrate into your trading system.

How To Trade With ATR
  1. What is Average True Range (ATR)
  2. How to calculate ATR
  3. How does ATR work
  4. Why use ATR
  5. How to use ATR in Trading
  6. How to trade with ATR – Closing words
  7. Try Tradingview Pro Charting Platform For 30 days

What is Average True Range (ATR)

The Average True Range is a technical indicator that was first introduced by J.Welles Wilder.

The indicator does not indicate or predict market direction. Instead, ATR measures the degree of volatility.

Originally, it was introduced for the commodities market. It is now widely used in stocks, futures, and Forex markets.

To understand how the indicator could help you in the trading, let’s look into the logic of it.

How to calculate ATR

To understand the calculation of ATR, you must first understand the definition of True Range. After all, ATR is just the average of a series of True Ranges.

By definition, the true range is the greatest of the following:

How To Trade With ATR – True Range Definition
  • High for the period less the Low for the period
  • High for the period less the Close for the previous period
  • Close for the previous period and the Low for the current period

Take note that, we are comparing the absolute values of the above 3 calculations.

For a 14-period Average True Range,

Current ATR= [(Prior ATR x 13) + Current TR] / 14

  • Multiply previous 14-period ATR by 13
  • Add the current True Range value
  • Divide the total by 14

How does ATR work

# High ATR value

An expanding ATR indicates that there is an increase of volatility in the market. The range of the price bars are getting wider.

A reversal bar with increased ATR indicates the aggressiveness of the move. ATR is not directional. And expansion of ATR value might indicate selling or buying pressure.

A sharp move with a spike of ATR value is usually unsustainable.

#Low ATR value

A low ATR value indicates the narrow range of price bars. Market is moving sideways for a period of time.

An extended period of low ATR indicates consolidation.

Why use ATR

ATR reflects the volatility of the instrument.

Higher ATR figures represent higher volatility and the instrument with lower volatility has a lower ATR.

With the understanding of the volatility, it helps the trader to better manage an entry, stop loss, and profit-taking decisions.

Let’s put it this way.

In a volatile market condition, a tight stop is likely to be triggered before the position even has a chance to develop.

While during the lower volatility period, a wide stop would be a waste. It does not optimize the overall profitability of the trading strategy.

On the other hand, ATR also helps traders to better understand the profit potential of a system. In a less volatile market, a closer take-profit might be more efficient.

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If you are interested in using Tradingview, you can try out the Pro membership FREE for 30 days. This is an excellent time to check out the powerful features of Tradingview charting.

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How to use ATR in Trading

There are two important notes you need to understand before start using ATR:

#1 It is a measurement of volatility

The most important thing you need to know is ATR does not measure or predict trend direction. Do not let others tell you otherwise.

It measures volatility.

#2 ATR is not a standalone indicator

Just like other indicators, ATR is not perfect. It should not be used as a standalone indicator that decides your entry, stop, and take-profit.

It should be used as a complement to your trading strategy. And most of the time, it is a great complement to a trading system.

Trailing Stop Placement

Trailing stop is a mechanism for you to exit a trade to either protect your profit or limit your loss.

If trailing stop is part of your trading system, ATR could be a great supplement for you.

As ATR measures the volatility of the market, it could be used to adjust the trailing stop.

Here is how you could use ATR for trailing stop:

  • When you are in a trade, check the current ATR reading
  • Multiply the ATR reading by 2
  • For Long position, stop loss = Entry- 2xATR
  • For short position, stop loss= Entry + 2xATR

It is a common suggestion to use 2xATR. It is not a magic number. It might not work for your market. But you get the idea here.

Give your position a breathing space by including current volatility into your stop loss order.

Daily Range Projection

Another idea to use ATR is to project the trading day’s extremes.

The idea is to use daily ATR values to project current day’s high and lows.

Here is the calculation

  • Calculate 20-day ATR up to yesterday’s close
  • Use current day’s High – 20-day ATR. This is the projected Low.
  • Use current day’s Low + 20-day ATR. This is the projected High.
  • These levels will change when the market makes a new high or new low.

The projected High and Low are the assumed extremes of the day. They could be treated as the day’s target or a trade location for counter trend trades.

How to trade with ATR – Closing words

Average True Range could be a useful tool for both swing trading and day trading alike. It offers traders another perspective on the market.

It tells you the volatility of the market. It helps to adjust trader’s expectations.

Again, average True Range is not a holy grail. Traders could benefit from it by integrating the indicator into a well-defined trading strategy.

Do you use ATR in your trading?

Do you have any questions or comments?

Leave me a line in the comment section. I am happy to help.

This post is part of my Back To the Basics of Trading series.

Are you trading with Indicators? – A few Suggestions

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Trading with Indicators
Trading with Indicators – 4 Suggestions

I have been working on coding my indicator and strategy on tradingview lately. I thought I would write a short post related to trading with indicators.

There is no shame or a sin using an indicator to trade. Our brains are wired differently.

Some of us can do quick math and analysis on the fly. Some of us rely on graphical presentations to make a decision.

If you have to use a technical indicator or indicators in your chart analysis, I have a few suggestions for you.

Trading with Indicators – 4 Suggestions

#1 Understand the math behind the indicator.

I can’t stress enough the importance of understanding the math behind any technical indicator that you are about to use.

You do not need to be a math genius. You do need to be able to understand basic math operations.

A technical indicator is basically a mathematical blend of data.

We receive open, high, low, close, and volume as the raw data on our chart. We can calculate the average of closing prices, finding the highest volume, or calculating the differences of mean, etc.

What is a moving average? It is the average closing price over a defined period. And What about MACD? It is the difference between long term and short term moving average.

You got what I mean? Indicators are the calculations of the raw data. Each calculation serves a purpose.

Why would you want to use a tool that you don’t understand to help you make financial decisions?

#2 Trade location first, indicator triggers second

Oh boy, the crossover of any lines on the chart always gets traders excited, isn’t it?

Hang on, don’t click that “Buy/Sell” button just yet.

One of the most common mistakes an indicator-trader makes is to follow the trigger signal blindly.

What is the secret of using an indicator trigger effectively?

Trade location.

Over the years of trading and learning, it was the recognition of trade location that turns my trading around.

What is a trade location?

A trade location is an area that is derived from the market structure. Traders are expected to take action at these locations.

A trade location could be a major support and resistance area, high/low volume node of volume profile, borders or trading range, or major swing high/low, etc.

Knowing a potential trade location gives you an edge. But knowing the location alone is not enough. You have to work on your entry technique.

There are many entry techniques. For example, in Futures trading, I am using order flow, while in Forex I have candlesticks patterns and other indicators to help me.

Same thing goes for indicators. After you have identified a valid trade location, a trigger of indicator might give you a good entry.

The point is, don’t use indicators alone. Use it to your advantage.

#3 Indicator, the less is more

One of the common mistakes newbie traders tend to make is having way too many indicators on a chart.

By stuffing the chart with indicators, you are complicating the decision making process. And to worsen the situation, indicators give you conflicting signals.

Try to limit the number of indicators on the chart. The lesser the better. Trying to simplify your decision making process is the key.

#4 Create your own indicator

I encourage you to create your own indicator. Why? Because it is a great learning experience.

By working on the code and the logic, you will learn to look at market data quantitatively. You will learn to understand the market you are trading better.

I always enjoy working on my own technical indicator. It gives me the focus I need, and helps to prove the concepts I have in mind.

You don’t need to create an indicator to start trading. Just take this exercise for the sake of learning.

Trading with indicator – Closing words

There is absolutely nothing wrong with trading with indicators. If it helps your trading, by all means, using it.

Having an indicator on your chart does not make you less professional.

Trading involves a series of decision making. From trade entry, to management, and to exit a trade. It involves different skill sets.

Indicator is one of the tools that can potentially help us in the decision making process. I hope the suggestions above help you to use your indicator more effectively.

If you are interested in learning more about trading, make sure to check out my Back to Basics series.

Do you use an indicator in trading? How do you use them?

Do you have any questions or comments? Feel free to drop me a line in the comment section.

My dinner conversation with a new trader

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Dinner conversation with a new trader
A Dinner conversation with a new trader

I do not normally discuss or talk about my trading outside cyberspace. The longer I traded, the more I feel uncomfortable talking about it. Maybe, I am just being lazy to explain ‘what is currency trading…bla bla bla’ or maybe I am just a person who is really bad in explaining thing clearly 🙂

Conversation with a new trader

I was having a great dinner at my friend’s place. I still miss the delicious roasted turkey, baked rice, sweet potatoes, etc 🙂 One young gentleman from India mentioned that he is interested in learning Forex trading and consider taking some expensive trading courses. He saw his friends playing with Fibonacci lines, indicators, etc (wow, he knows these terms..) which is accurate 80% of the time. I kept quiet. I really did not want to get into the discussion. However, one of my friends who knows I am trading actively pointed him to me. Oh well…

In the hindsight, probably I was not too friendly to him. My ‘advice’ to him was:

“Yes, I am trading currency actively. However, I do not teach. The risk of this business is too high, so I do not encourage young people to go into that. I am in this business long enough to tell you that. 90% of retail traders failed. I am a little lucky to manage to earn some small money. But, seriously, I really don’t encourage”

Looking at his face…I know my words are not encouraging. ‘Go and try demo accounts, make sure you are able to make some money there, then only start thinking about forex trading’

picture-059

What kind of advice is this? I had just given a cold blanket to a young trader wannabe. My bad.

I am not sure if I did the right thing. He might probably go for some expensive trading courses and start with his friend’s 80% accuracy system. That’s not my problem. He might even think I am being arrogant by not sharing anything with him. At least, I did not commit a sin that by telling him, ‘forex is a wonderful 24-hour market, where you can make money anytime, anywhere you want’.

Well…I think I did the right thing after all.

The lesson here? Don’t ask Gav out for dinner and talk about trading.

This blog post was first written back in June 8, 2009. I review it and repost it again as I thought it might be useful to new traders.

If you really keen to learn trading, check out my posts in the Back to Basics of Trading series.

Linda Raschke’s 50 Time-tested trading rules

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Linda Raschke's Time-tested trading rules
Linda Raschke’s Time-tested trading rules

I read an article by Linda Bradford Raschke about Trading rules and wrote this blog post back in 2006. It is a long but great list. I have reviewed the blog post and publish it again, as I thought it is very useful to new traders.

Maybe you have already known these rules, but, maybe you are just violating them every other day. Maybe, It is time to review your trading rules.

Here are the rules I quoted from her article:

Linda Raschke’s Time-tested Trading Rules

  1. Plan your trades. Trade your plan.
  2. Keep records of your trading results.
  3. Keep a positive attitude, no matter how much you lose.
  4. Don’t take the market home.
  5. Continually set higher trading goals.
  6. Successful traders buy into bad news and sell into good news.
  7. Successful traders are not afraid to buy high and sell low.
  8. Successful traders have a well-scheduled planned time for studying the markets.
  9. Successful traders isolate themselves from the opinions of others.
  10. Continually strive for patience, perseverance, determination, and rational action.
  11. Limit your losses – use stops!
  12. Never cancel a stop loss order after you have placed it!
  13. Place the stop at the time you make your trade.
  14. Never get into the market because you are anxious because of waiting.
  15. Avoid getting in or out of the market too often.
  16. Losses make the trader studious – not profits. Take advantage of every loss to improve your knowledge of market action.
  17. The most difficult task in speculation is not prediction but self-control. Successful trading is difficult and frustrating. You are the most important element in the equation for success.
  18. Always discipline yourself by following a pre-determined set of rules.
  19. Remember that a bear market will give back in one month what a bull market has taken three months to build.
  20. Don’t ever allow a big winning trade to turn into a loser. Stop yourself out if the market moves against you 20% from your peak profit point.
  21. You must have a program, you must know your program, and you must follow your program.
  22. Expect and accept losses gracefully. Those who brood over losses always miss the next opportunity, which more than likely will be profitable.
  23. Split your profits right down the middle and never risk more than 50% of them again in the market.
  24. The key to successful trading is knowing yourself and your stress point.
  25. The difference between winners and losers isn’t so much native ability as it is discipline exercised in avoiding mistakes.
  26. In trading, as in fencing, there are the quick and the dead.
  27. Speech may be silver but silence is golden. Traders with the golden touch do not talk about their success.
  28. Dream big dreams and think tall. Very few people set goals too high. A man becomes what he thinks about all day long.
  29. Accept failure as a step towards victory.
  30. Have you taken a loss? Forget it quickly. Have you taken a profit? Forget it even quicker! Don’t let ego and greed inhibit clear thinking and hard work.
  31. One cannot do anything about yesterday. When one door closes, another door opens. The greater opportunity always lies through the open door.
  32. The deepest secret for the trader is to subordinate his will to the will of the market. The market is the truth as it reflects all forces that bear upon it. As long as he recognizes this he is safe. When he ignores this, he is lost and doomed.
  33. It’s much easier to put on a trade than to take it off.
  34. If a market doesn’t do what you think it should do, get out.
  35. Beware of large positions that can control your emotions. Don’t be overly aggressive with the market. Treat it gently by allowing your equity to grow steadily rather than in bursts.
  36. Never add to a losing position.
  37. Beware of trying to pick tops or bottoms.
  38. You must believe in yourself and your judgment if you expect to make a living at this game.
  39. In a narrow market, there is no sense in trying to anticipate what the next big movement is going to be – up or down.
  40. A loss never bothers me after I take it. I forget it overnight. But being wrong and not taking the loss – that is what does the damage to the pocketbook and to the soul.
  41. Never volunteer advice and never brag of your winnings.
  42. Of all speculative blunders, there are few greater than selling what shows a profit and keeping what shows a loss.
  43. Standing aside is a position.
  44. It is better to be more interested in the market’s reaction to new information than in the piece of news itself.
  45. If you don’t know who you are, the markets are an expensive place to find out.
  46. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word – Nobody! Thus the successful trader does not base moves on what supposedly will happen but reacts instead to what does happen.
  47. Except in unusual circumstances, get in the habit of taking your profit too soon. Don’t torment yourself if a trade continues winning without you. Chances are it won’t continue long. If it does, console yourself by thinking of all the times when liquidating early reserved gains that you would have otherwise lost.
  48. When the ship starts to sink, don’t pray – jump!
  49. Lose your opinion – not your money.
  50. Assimilate into your very bones a set of trading rules that works for you.

Time-tested trading rules – Closing Words

You don’t have to agree and follow the whole list, I don’t. However, there is wisdom in the list.

Trading is a simple but tough business. Keep it as simple as you can. Rules like these are useful to set your mindset right. Have the right mindset, clear routine, and self-discipline, your trading journey will be more enjoyable and, hopefully, profitable.

If you are new to trading, do check out my Back to Basics of trading series, and also the Resource page if you are looking for trading tools.

Which rule(s) is your favorite? Which one doesn’t sound right to you? Let’s discuss this in the comment section.

Try Tradingview Pro Charting Platform For 30 days

Tradingview is my go-to FX charting and trading solution. I have done extensive coding and trading on the platform. I am happy to recommend them.

If you are interested in using Tradingview, you can try out the Pro membership FREE for 30 days. This is an excellent time to check out the powerful features of Tradingview charting.

Tradingview 30-day FREE Pro membership trial

Most Useful Candlesticks Patterns

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Most useful Candlesticks patterns
14 Most useful Candlesticks Patterns For Day Traders

[Update 2020] I wrote this post back in 2006 when I was just starting day trading. I have decided to review and update this post. The materials presented in this post are still applicable and useful to beginner traders.

I am hitting the wall while working on backtesting programming. I decided to take a break and write a post about candlesticks stuffs that I have recently learned. There are just too many patterns of candlesticks. And I was confused. And I was pissed. And I gave up.

I know the value of candlesticks for day trading. With help from Dave, I am looking at a couple of useful patterns and trying to integrate into my backtesting program of the dummy system. I tried to search on the internet, books and I have sorted out these few valuable patterns.

14 Most Useful Candlesticks Patterns

Most Useful Candlesticks Patterns
  1. Abandoned Baby
  2. Doji Star
  3. Kicking
  4. Mat Hold
  5. Matching Low
  6. Morning Doji Star
  7. Evening Doji Star
  8. Evening Star
  9. Morning Star
  10. Three Inside Up
  11. Three Outside Down
  12. Three Inside Down
  13. Three Outside Up
  14. Dark Cloud Cover


Abandoned Baby

A long black day is followed by a Doji that gaps in the direction of the trend. Then a white day occurs gapping in the opposite direction with no overlapping shadows.

In a downtrend or within a pullback of an uptrend, the market gaps down but does not continue its downward movement. Instead, enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. This isn’t necessarily bullish, but it’s certainly less bearish. The pattern is confirmed by the next day’s gap up and rally.

Doji Star

Doji Star

A long black day is followed by a Doji that gaps in the direction of the trend. The shadows of the Doji should be short.

In a downtrend or within a pullback of an uptrend, the market gaps down but does not continue its downward movement. Instead enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. The halt of the downtrend signifies the possibility of a reversal, so confirmation is needed with a strong third day (preferably with volume behind it).

Kicking

Kicking

A Black Marubuzo (open is the high of the day and the close is the low of the day) day is followed by a White Marubuzo (open is the low of the day and the close is the high of the day) day that gaps in the opposite direction.

The current trend is not very important with a bullish Kicking pattern. The fact that the stock can gap up and rally to close at its high is bullish regardless of the previous trend. Use volume on a white day to confirm the movement.

Mat Hold

Mat Hold

A long white day in an uptrend is followed by a relatively small black day that gaps in the direction of the trend. The next two days continue the brief pullback and are small days that stay within the range of the first day. The fifth day is a long white day that closes above the close of the first day and continues the uptrend.

In an uptrend, a long white day is followed by a brief pullback (preferably on lightish volume). The fifth day simply continues the trend. The brief pullback is nothing more than a few days off for the bulls.

Matching Low

Matching Low

A long black day is followed by another black day with equivalent closes both days.

In a downtrend or during a pullback within an uptrend, a long black day occurs signaling the bears being in control. The stock gaps up the next day but then sells off to close at the same level as the previous day. The more times a stock can successfully test and hold a low, the higher the chance a reversal will occur once the seller become exhausted. Strength the following day with volume would confirm the pattern.

Morning Doji Star

Morning Doji Star

A long black day is followed by a Doji that gaps in the direction of the trend. The third day is a white day which closes in the top half of the black day.

In a downtrend or during a pullback within an uptrend, the market gaps down but does not continue its downward movement. Instead enough bulls step up to bring supply and demand back into equilibrium and the stock churns in place. This is the bullish Doji Star formation. A subsequent follow through gap up that closes above the midpoint of the black day completes the Morning Doji Star and confirms the reversal.

Evening Doji Star

Evening Doji Star

A long white day is followed by a Doji that gaps in the direction of the trend. The third day is a black day that closes in the bottom half of the white candle.

In an uptrend or within a bounce of a downtrend, the market gaps up but does not continue its upward movement. Instead enough bears step up to bring supply and demand back into equilibrium and the stock churns in place. This is the bearish Doji Star formation. A subsequent follow through gap down that closes below the midpoint of the white day completes the pattern and confirms the reversal.

Evening Star

Evening Star

A long white day is followed by a small body that gaps in the direction of the trend. The third day is a black day that closes in the bottom half of the white candle.

In an uptrend or within a bounce of a downtrend, the market gaps up but does not continue its upward movement. Instead enough bears step up to bring supply and demand back into equilibrium so a small body forms. A subsequent follow through gap down that closes below the midpoint of the white day completes the pattern and confirms the reversal.

Morning Star

Morning Star

A long black day is followed by a small day that gaps in the direction of the trend. The third day is a white day which closes in the top half of the black day.

In a downtrend or during a pullback within an uptrend, the market gaps down but enough buyers step in to halt the weakness. The lack of ability of the bears to press the issue indicates the downtrend may be weakening. The gap up and rally that closes the white day above the top half of the black day confirms the reversal if accomplished with a surge in volume.

Three Inside Up

Three Inside Up

A bullish Harami pattern is followed by a white day that has a higher close than the second day.

In a downtrend or during a pullback within an uptrend, a bullish Harami pattern forms. This pattern has low reliability, but when it is followed up with another white day, a reversal becomes much more probable ? especially when accompanied by volume.

Three Outside Down

Three Outside Down

A bearish Engulfing pattern is followed by a black day whose close is lower than the second day.

In an uptrend or within a bounce of a downtrend, a bearish Engulfing pattern forms. By itself this pattern has moderate reliability as a reversal indicator, but when the it is followed by another black day (preferably on strong volume), the overall pattern becomes much more reliable.

Three Inside Down

Three Inside Down

A bearish Harami pattern is followed by a black day whose close is lower than the second day.

In an uptrend or within a bounce of a downtrend, a bearish Harami forms. By itself this pattern has moderate reliability as a reversal pattern, but when followed by a weak day (preferably with a pick up in volume) the overall pattern becomes much more reliable.

Three Outside Up

Three Outside Up

A bullish Engulfing pattern is followed by a white day whose close is higher than the second day.

In a downtrend or during a pullback within an uptrend, a bullish Engulfing pattern forms. By itself the pattern has moderate reliability as a reversal indicator, but when the it is followed by another white day (preferably on strong volume), the overall pattern becomes much more reliable.

Dark Cloud Cover

Dark Cloud Cover

A long white day is followed by a black day which gaps above the high of the white candle and then closes below the midpoint of the first day’s body.

In an uptrend or within a bounce of a downtrend, the stock gaps up and immediately encounters sellers who push the stock back down. This simply signifies the possibility of a reversal that is more reliable if the gap up occurs at resistance and the black day is accompanied by a surge in volume.

Most Useful Candlesticks Patterns – Closing Words

There you have it. My list of most useful candlesticks patterns for day trading.

However, bear in mind that these are not holy grails. The best way to use any market pattern is to play it with the context of the market.

Understand the context of the market, define your trade location, and look for your favorite chart or candlesticks patterns to play out.

If you are looking to learn more about trading, remember to check out the Back To Basics series of blog posts. I have compiled a list of articles that I feel are useful to beginners’ traders.

Also, feel free to check out the Resource page to see the tools I use in my trading.

That’s it.

Be a Better Trader, Today.

What is VWAP trading? A beginner’s guide

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What is VWAP trading
What is VWAP Trading?

This website is free and supported by readers. This post may contain affiliate links. Read the disclosure for more info.

Volume Weighted Average Price VWAP is one of the most popular and important day trading indicators.

VWAP is widely used by institutional traders to guide their positioning decisions. In recent years, more and more retail traders are utilizing the indicator to make trading decisions.

In this post, let’s look at what is VWAP trading. How can we apply VWAP into our trading?

Table Of Contents
  1. What is VWAP
  2. How to calculate VWAP?
  3. How do institutional traders use VWAP?
  4. What is VWAP trading? The applications of VWAP
  5. What is VWAP trading – Final Thoughts
  6. Try Tradingview Pro Charting Platform For 30 days

What is VWAP

As I stated at the beginning of the post, VWAP stands for Volume Weighted Average Price. It is different from VWMA, I have written a blog post on VWAP vs VWMA to show the difference. Feel free to check it out.

The calculation of VWAP resets every session. It takes the current session’s price and volume information into consideration.

VWAP outputs the average price of the security so far during the session. It is a cumulative indicator that does not drop data as a moving average does.

Just to refresh your knowledge:

Moving average is an average of data over a fixed period. As time progresses, old data points are dropped out while the latest data is included in the calculation.

A simple moving average formula looks like this:

SMA = (P1 + P2 +….Pn) / n

Where:

P= Datapoint, e.g security price

n= number of time periods

In the following section, I will show you the calculation of VWAP, you will see the indicator does not drop out data over time.

How to calculate VWAP?

There are 2 main components of VWAP: Typical Price and Volume.

A typical price is the average of the High, Low, and Close.

Typical Price = (H+L+C)/3

Here is the formula of VWAP

Explanation:

The easiest way to explain the VWAP calculation is by using a spreadsheet. (I have shared the spreadsheet here).

To calculate VWAP, we take the sum of (Typical price x Volume) and divide it with the total volume of the current session.

Below is the 5-min data for 06 August 2020 extracted from TradingView.com. Most Forex brokers offer tick volume now.

calculate vwap with spreadsheet
Calculate VWAP by using Spreadsheet

The purpose is to show you the calculation of the VWAP.

Step 1: Calculate the Typical Price.

The first step is to calculate the average of High, Low, and Close prices for the given period. The average is called the typical price.

At 17:00 the High is 0.72381, Low is 0.72346, and Close is 0.72368. The volume for the period is 47.

The typical price for the period is

Typical Price = (0.72381 + 0.72346 + 0.72368)/3 = 0.72365

For 17:05, the typical price is (0.72377+ 0.72344 + 0.7237)/3 = 0.72364

Step 2: Multiply the typical price with volume.

For 17:00 Typical Price x Volume = 0.72365 x 47 = 34.01155

For 17:05 Typical Price x Volume = 0.72364 x 36 = 26.05092

We need the cumulative sum of (Typical Price x Volume).

For 17:05 the cumulative of (Typical Price x Volume) =

[Typical Price (17:00) x Volume (17:00)] + [Typical Price (17:05) x Volume (17:05)]

34.01155 + 26.05092 = 60.06247

Step 3: Calculate the cumulative Volume

At 17:05 the cumulative volume will be volume (17:05) + volume (17:00)

=36+47 = 83

Step 4: Calculate the VWAP

Finally, to calculate VWAP,

VWAP = Cumulative (Typical Price x Volume) / Cumulative Vol

At 17:05, VWAP = 60.06248/83 = 0.72364

That’s it. We have the VWAP calculated.

VWAP is a cumulative indicator, as the day progresses, it continues to take in new price and volume information into consideration without dropping out old data points.

The calculation of VWAP stops at the end of the session or trading day.

How do institutional traders use VWAP?

Institutional traders use VWAP as a benchmark for their trade executions.

Institutional traders buy or sell a large number of contracts or shares. They want to reduce the impact as much as possible. They do not want to attract attention, causing a spike in volume, and affect the price.

To avoid that, they develop automated trading strategies that trade small chunks of shares or contracts. They make sure their closing prices are as close as possible to the VWAP.

To bring the market price back to the average, they buy below VWAP and sell above it.

What is VWAP trading? The applications of VWAP

In this section, I want to focus on how retail traders use VWAP in their trading.

There are 2 main applications of VWAP adopted by traders: Trend confirmation and Mean Reversion trading.

Use VWAP in Trend trading for trend confirmation

Use VWAP to confirm trend
What is VWAP Trading – VWAP as trend confirmation tool

As VWAP is calculated by using the cumulative sum of price and volume during the session, it could be used as a trend confirmation tool.

The slope of VWAP is often used to determine the trend of the day.

A rising VWAP could indicate a bullish trend while a decreasing VWAP indicates a bearish market trend.

Mean Reversion Trading Strategy

What is vWAP Trading – Mean Reversion Strategy

Mean Reversion is one of the most popular day trading strategies. VWAP is a great tool to implement this strategy.

How does Mean Reversion work?

Mean Reversion strategy works on the assumption that there is a mean or fair price level. The market tends to fluctuate around this mean.

So when the market deviates far from the mean, it will tend to reverse and revert to the mean price level.

There are many ways to determine if the market is overvalued. Some traders use indicators like RSI or Bollinger bands. Each has its merit.

With VWAP, I like to use the standard deviations of VWAP to guide me. This is not a holy grail, but a guide to show me how far the market has moved away from its mean.

Free VWAP Indicator for TradingView

If you are using TradingView, I have shared a free script that will plot the VWAP line, standard deviation bands, and extensions. Feel free to add it to your account.

Free VWAP indicator on Tradingview

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The Mean Reversion strategy works well in the choppy market. And it best suits short term traders.

What is VWAP trading – Final Thoughts

VWAP is an excellent day trading tool, it is a good barometer that shows the value of the current trading session.

Just like all trading indicators, it is not a holy grail.

Before you jump in and start trading with VWAP, make sure you have done the due diligence. Testing, verifying, and understanding how the indicator could help your trading.

How do you use VWAP in your trading?

Do you have any questions?

Feel free to leave me a comment below. I am happy to help.