INDICATORS
Examining The VWAP Approach
The Midas Touch
by Andrew Coles, PhD
The volume-weighted average price can be applied to daytrading and short-term swing trading. Here's how.IN a Technical Analysis of STOCKS & COMMODITIES article published in May 2001, George Reyna drew attention to how a certain type of volume-weighted average price (VWAP) calculation can be a powerful predictor of support and resistance associated with major reversals off the daily charts. This is a technique that would be of interest to the position trader.
The ingenuity behind this unique application of the VWAP principle can only be appreciated in the context of standard VWAP calculations, which have been extensively applied in the trading industry for many years. A standard VWAP calculation represents the total value of shares traded in a particular stock on a given day divided by the total volume of shares traded in that stock on that same day. This standard calculation is thus a method of pricing transactions and is typically used as a benchmark to measure the efficiency of institutional trading or the performance of traders themselves.
As an example, in the mutual and pension funds industry it is used as a trading benchmark: the point of using a VWAP trading target is to ensure that the trader executing the order does so in line with the market volume. This way, transaction costs are reduced by minimizing market impact.
An extension of this idea is known as "guaranteed VWAP execution," whereby a broker may guarantee execution of an order at the VWAP in order to earn the trader's commission. As a means of evaluating trading performance, this standard calculation would figure in positive or negative appraisals being given to a long trade lower than or above its daily VWAP, respectively, and vice versa for short trades. A specific illustration is supplied by trader Kevin Haggerty in an interview he gave to S&C in 1999. In conjunction with other price and volume considerations, Haggerty examines whether a stock price has closed above its daily VWAP.
However, the aim of Reyna's study was to show how a new type of VWAP calculation created by the late Paul Levine, who was a physicist as well as a technical analyst, can be used to create nonlinear support and resistance curves predictive of major trend reversals. The present study extends this topic not only by exploring Levine's VWAP approach to technical analysis more deeply, but also, and most important, by applying the same VWAP technology to intraday charts and daytrading.
...Continued in the September issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the September 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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