Curious about how Volume Weighted Average Price (VWAP) helps you buy low and sell high in the cryptocurrency market? Find out in our guide!
Volume Weighted Average Price (VWAP) is an important tool for you to study the crypto market sentiment and identify optimal entry and exit points.
For instance, following the SEC’s regulatory actions, Binance experienced a spike in BUSD trading volumes. However, the market share of BUSD Stablecoins has since declined. As of February 13th, BUSD’s market share had fallen from 43.3% to 25.7%. VWAP can help you anticipate this kind of market sentiment by factoring in both price and volume.
VWAP provides a better understanding of a cryptocurrency’s true value compared to simple average price. This article explains VWAP, its applications in the crypto market and how to leverage it for more informed trading decisions.
Recommended reading: Analyzing The Cryptocurrency Market Efficiency: The Full Guide
Key Takeaways
- Unlike simple average price, VWAP factors in both price and volume to provide a better understanding of a cryptocurrency’s true value.
- VWAP helps identify potential buying and selling zones by reflecting buying and selling pressure through volume analysis.
- You can minimize the difference between your execution price and the overall average price to reduce impact cost by aiming to fill orders closer to the VWAP.
- For stronger trading signals, use VWAP in conjunction with technical indicators like moving averages and RSI to confirm trends and identify overbought/oversold conditions.
What is Volume Weighted Average Price (VWAP) in Crypto?
In crypto trading, Volume Weighted Average Price (VWAP) represents the average price at which a cryptocurrency has been traded throughout a specific timeframe, typically a day, but it can be applied to shorter intervals as well.
Unlike a simple average that just takes the sum of all prices and divides by the number of trades, VWAP assigns more weight to prices where there was higher trading volume. This provides a more accurate picture of the overall market sentiment for a particular cryptocurrency.
To understand better, imagine you are buying groceries throughout the day. You might buy apples at $1/lb in the morning, then find them on sale for $0.75/lb in the afternoon.
A simple average price would just add those numbers and divide by two, giving you $0.875/lb. But that doesn’t account for how much of each you bought. VWAP (Volume Weighted Average Price) solves this by considering both price and volume.
Traditional vs. Volume Weighted Average Price
Consider buying three Bitcoin (BTC) at $40,000 each, then later buying two more at $45,000 each. A simple average price would be ($40,000 x 3 + $45,000 x 2) / 5 = $42,000. However, this doesn’t reflect the fact that you bought more BTC at the higher price point.
VWAP takes volume into account. If the total volume you bought represents 1% of the total day’s trading volume, VWAP would consider the overall market activity.
Let’s say the average price across the entire day, factoring in all trades, was $43,000. Your VWAP would likely be closer to $43,000 since your purchases coincided more with the market average price.
Some institutional investors, often nicknamed “whales” due to the massive size of their holdings, utilize VWAP to ensure their large trades don’t drastically move the price of a cryptocurrency. By strategically placing buy or sell orders closer to the VWAP, they can minimize market impact and potentially achieve a better average price.
The VWAP Formula
The VWAP formula might seem intimidating at first glance, but it’s a straightforward calculation:
VWAP = Σ (Price x Volume) / Σ Volume
Here’s a breakdown:
- Σ (Price x Volume): This symbol (Sigma) tells us to sum (add up) the product of price and volume for every single trade.
- Σ Volume: This sums up the total volume for all the trades within the chosen timeframe.
Dividing the sum of price multiplied by volume by the total volume, we get the VWAP, a more representative picture of the average price considering trading activity.
Recommended reading: Multi-Time Frame Analysis in the Cryptocurrency Market
Why VWAP is Important for Crypto Trading
Prices can swing wildly within short periods in the cryptocurrency market. VWAP helps navigate this volatility in two key ways:
Addressing Market Volatility
VWAP smooths out price fluctuations by incorporating trading volume. This provides a more stable reference point for making informed trading decisions compared to relying solely on the current market price.
VWAP acts like a filter which considers the volume at which each price point was traded to provide a more stable reference point. This smoothed-out line helps you identify the trend more clearly, as opposed to getting caught up in every minor price swing.
The VWAP line on the Bitcoin chart might be steadily rising even though the price itself has some ups and downs. This suggests an upward trend despite the short-term volatility, potentially indicating a buying opportunity.
Gauging Buying and Selling Pressure
Since VWAP considers volume, it reflects the overall buying and selling pressure in the market. Take Ethereum (ETH) for example, If the price is trading above the VWAP, it suggests more buying activity is pushing the price up.
This increased buying pressure might signal a potential upward trend and a buying opportunity for you.
If the price of XRP for example, is trading below the VWAP line, it indicates that there’s more selling pressure driving the price down. This dominance of sellers could be a sign of a potential downtrend and a potential opportunity to exit a long position or even initiate a short sell trade.
Leveraging VWAP for Strategic Crypto Trading
Due to the removal of zero-fee trading for USDT, Binance experienced a 10.8% decline in its market share in May 2023.
VWAP goes beyond just understanding average price; it’s a powerful tool for making strategic trading decisions. Here’s how you can leverage VWAP to identify optimal entry and exit points:
Buying Below VWAP: Targeting Value
Imagine a scenario where the price of a cryptocurrency is trading below the VWAP. This suggests that overall, buyers haven’t been that active and the price might be undervalued. Here’s how VWAP can be a buying signal:
- Potential Accumulation Zone: A price consistently trading below VWAP indicates a possible buying opportunity. This doesn’t guarantee a price surge, but it suggests there might be some value to be captured.
- Waiting for Confirmation: While a price below VWAP is a good starting point, it’s wise to look for confirmation signals before diving in. This could involve technical indicators like bullish candlestick patterns or positive news about the cryptocurrency.
Selling Above VWAP: Capturing Profits
On the flip side, if the price is consistently trading above the VWAP, it suggests buying pressure is driving the price up. This could be a good time to consider selling and capturing some profits.
- Profit-Taking Opportunity: When the price climbs above the VWAP and shows signs of potentially continuing its upward trend, it might be a good time to take some profits off the table. This helps lock in gains and avoid giving back profits if the price retraces.
- Trailing Stop-Loss Orders: You can utilize trailing stop-loss orders in conjunction with VWAP to manage risk while the price moves favorably. A trailing stop automatically raises your sell order price as the price goes up, ensuring you capture profits but limit potential losses if the price reverses.
Combining VWAP with Other Indicators
While VWAP is valuable on its own, its true power lies in its synergy with other technical indicators. Here’s how VWAP can be combined with popular indicators for more robust trading signals:
VWAP and Moving Averages (MAs) for Trend Confirmation
Moving Averages (MAs) are another widely used technical indicator that smooths out price data and helps identify trends. Combining VWAP with MAs can provide stronger confirmation signals:
- Price Crossing Above/Below MAs: When the price decisively crosses above a short-term moving average (e.g., 50-day MA) and trades consistently above the VWAP, it strengthens the bullish trend signal. Conversely, a price crossing below the MA and trading consistently below VWAP suggests a potential downtrend.
- VWAP as Dynamic Support/Resistance: In a confirmed uptrend, the VWAP can act as a dynamic support level. Conversely, in a downtrend, the VWAP can act as dynamic resistance. Price bouncing off the VWAP in these scenarios can signal potential continuations of the trend.
VWAP and RSI for Overbought/Oversold Signals
The Relative Strength Index (RSI) is a popular indicator that measures the momentum behind price movements and identifies potential overbought or oversold conditions. Here’s how VWAP can complement RSI:
- Divergence Between Price/VWAP and RSI: When the price (and VWAP) are making new highs but the RSI fails to follow suit (divergence), it can be a sign of weakening bullish momentum and a potential reversal. Conversely, a price dipping below the VWAP while the RSI doesn’t fall as much (divergence) could indicate an oversold condition and a possible buying opportunity.
While VWAP shines in the world of cryptocurrency, its applications extend far beyond. If you trade in traditional stock markets, you can also leverage VWAP to gain insights into buying and selling pressure and make informed decisions about stocks, bonds and other assets.
Recommended reading: OM Token Sees 19% Surge to Become Crypto Market’s Top Performer
Advantages of Using VWAP in Crypto Trading
Here are some of the advantages of using VWAP in crypto trading:
Reduced Impact Cost
In volatile markets like cryptocurrency, VWAP can help minimize the difference between your execution price and the overall average price (VWAP). This translates to reduced impact costs, especially for larger trades.
Referencing the VWAP throughout your buying process lets you spread out your order execution over time, get closer to the average price (VWAP) and reduce the overall cost of your large trade.
For example, let’s assume the current market price for BTC is $40,000, but the VWAP is $38,000. Placing smaller orders strategically throughout the day and targeting the VWAP allow you to potentially acquire your desired amount of BTC closer to the average price. This saves you money on your trade.
Informed Entry and Exit Points
VWAP provides valuable insight into buying and selling pressure by considering volume. A price consistently below VWAP suggests a potential buying zone.
Take for instance, If Ethereum’s (ETH) price consistently trades below the VWAP line on the chart , it might indicate an accumulation phase where more buyers are entering the market. This could be a good opportunity to enter a long position on ETH.
On the other hand, a price consistently above the VWAP line might indicate selling pressure and a possible profit-taking opportunity. If XRP’s price remains above the VWAP for an extended period, it could be a sign that traders are taking profits, potentially signaling a trend reversal.
This might be a good time to exit a long position or even initiate a short sell trade on XRP.
Gauging Market Sentiment
By incorporating volume, VWAP offers a more nuanced view of overall market sentiment compared to simple average price. This helps you understand if buying or selling forces are dominating the market.
For example, if the price of Litecoin (LTC) is rising but remains below the VWAP line. This suggests that the price increase might be fueled by speculation or short-term buying, lacking strong buying pressure (volume) behind it. This could be a sign of a potentially unsustainable price move.
Trend Confirmation
When combined with other technical indicators like moving averages, VWAP can strengthen trend signals. For example, a price consistently above VWAP and a short-term moving average reinforces a bullish trend.
Reduced Slippage
Slippage is the difference between your intended price and the actual execution price of your order. Especially during periods of high volatility, VWAP can help reduce slippage. This is done by aiming to fill orders closer to the VWAP.
Disadvantages of Using VWAP in Crypto Trading
Here are some of the advantages of using VWAP in crypto trading:
Lagging Indicator
VWAP is a lagging indicator, meaning it relies on historical data. It doesn’t predict future price movements, so it’s important to use it in conjunction with other indicators that analyze price momentum.
Imagine a surging price for BNB. The VWAP line will likely lag behind the current price, reflecting the average price at which BNB was traded before the recent surge. VWAP can’t tell you if the price will continue to rise or if a correction is imminent.
Limited Use in Low-Volume Markets
For cryptocurrencies with low trading volume, VWAP may not be as reliable. With fewer data points, the VWAP might not accurately reflect the overall market sentiment.
For instance, a new, low-volume altcoin might experience a sudden price spike due to a small buying spree. In this case, the VWAP might not be significantly impacted, even though the price movement might be significant for that particular cryptocurrency.
Market Manipulation Susceptibility
In some cases, manipulative trading activity can distort VWAP. Large, coordinated buying or selling orders can skew the VWAP, making it less reflective of genuine market sentiment.
Imagine a whale (a large investor) placing massive sell orders for XRP, driving the price down significantly. This sudden surge in selling volume would significantly impact the VWAP, potentially making it appear as if there’s more overall selling pressure than might actually be the case.
Complexity for New Traders
Understanding and effectively utilizing VWAP requires some technical knowledge. If you are a new trader, you might find the concept and implementation of VWAP strategies challenging.
Not a Guarantee of Success
VWAP is a valuable tool, but it’s not a magic formula for success. It should be used within a broader trading strategy that incorporates risk management and other technical analysis techniques.
Advanced VWAP Technique
Combining a 5-minute day trading strategy with a Heikin Ashi chart and the application of VWAP (Volume-Weighted Average Price) has proven to be highly successful in the stock market. It outperformed 93% of stocks where a buy-and-hold approach was used.
While the win rate was only 29%, an impressive reward/risk ratio of 4.1 resulted in positive outcomes across a wide range of stocks.
Beyond basic applications, VWAP offers more sophisticated techniques for you if you are an experienced trader:
Time-Weighted VWAP (TWAP)
Imagine you’re a whale (a large investor) planning to buy a significant amount of Cardano (ADA). Placing a large market order could significantly push the market price upwards.
Time-Weighted VWAP (TWAP) helps you to factor in time alongside price and volume. It allows you to spread out your buy orders over a specific timeframe. By doing this, you aim to achieve a better average price and minimize the market impact of your large order.
For instance, if the current market price for ADA is $1.00, the TWAP calculation might indicate an average price of $0.95 over the next hour if you spread out your buying proportionally.
So using a TWAP strategy allows you to place smaller orders throughout the hour, target the TWAP, and potentially acquire your desired amount of ADA closer to the average price. This helps to reduce your overall cost.
Recommended reading: Tokenomics and Incentive Mechanisms in the Cryptoverse
Order VWAP (OVWAP)
This algorithmic trading strategy involves breaking down a large order into smaller chunks and executing them at prices that bring the average fill price closer to the overall VWAP. This helps reduce market impact and potentially achieve a more favorable average execution price.
Here’s how it works: Let’s say you have a large sell order for Chainlink (LINK). OVWAP breaks down your large order into smaller chunks. An algorithm then executes these smaller orders at prices that bring the average fill price closer to the overall VWAP for LINK.
The benefit? Reduced market impact and potentially a more favorable average execution price for your large sell order. This strategy helps you sell your LINK without causing a major price crash and potentially even benefits you by achieving a better average selling price compared to a single large sell order.
Conclusion
Volume Weighted Average Price (VWAP) equips you with a powerful tool to evaluate the cryptocurrency market.
Cryptocurrency trading can be challenging. By considering both price and volume, VWAP offers a more comprehensive picture of market sentiment compared to relying solely on the current market price. This insight allows you to identify potential entry and exit points, gauge buying and selling pressure and potentially reduce the impact cost of your trades.
The VWAP is a lagging indicator and susceptible to manipulation in some instances. For best results, integrate VWAP with other technical indicators and sound risk management practices.
