VWAP Basics: Price, Volume, and Market Insight

Introduction

To become a successful trader, you need to learn, be emotionally stable, rehearse and enter the market only when you are equipped with appropriate knowledge. What best equips you with these prerequisites is studying how to perform technical and fundamental analysis. If you are interested in scalping, day trading or short-term trading in general, you should study technical analysis in detail. Fundamental analysis should be your goal if swing trading, trend trading or spot trading attracts you. The choice of an indicator or a combination of many is also crucial in this regard. Of all those indicators, volume holds an extremely important place.

What is the Volume Indicator?

Price data of any coin on an exchange shows your price candles as well as volume candles. These candles reveal how much of an asset was traded in the selected time frame and what was the traded volume in $USDT, $USDC or whatever pair you have chosen for yourself. These candles are crucial as they indicate how much interest traders show in moving the price. Increasing price without much volume may not persist for long as even a slight selling pressure may bring it down. Similarly, strong red volume candles must accompany a downtrend to confirm the real momentum downwards.

What is Volume-Weighted Average Price?

You might have heard and seen moving average (MA) indicators. These indicators simply find the combination of the closing prices for the selected time frame and divide it by the time frame value. VWAP (short for volume-weighted average price) gives due importance to the volume factor. For example, in a one-hour candle if you see 10 $BTC traded at $88,000, 5 $BTC at $87,500, and 15 $BTC at $88,200, the VWAP will be closer to 88,200 because the largest volume of the asset occurred at that price. So, the volume-weighted average price is a technical analysis indicator that provides average price of an asset weighted by the traded volume in a specific time frame.

How to Calculate VWAP

A few trading platforms provide you in-built VWAP indicator, but in case you do not find it on yours, you can easily calculate it using simple math.

VWAP = (TP1​×V1​) +(TP2​×V2​) +(TP3​×V3​) +(TP4​×V4​) +(TP5​×V5​)​

                                    V1+V2+V3+V4+V5

TP (Typical Price) = (High + Low + Close) / 3

Since this can be too tedious to understand at times, we can simplify it by re-writing it as under:

VWAP = ∑ (Typical Price * Volume) / ∑ Volume

After understanding the formula, the steps are quite simple.

1. Let’s suppose you want to calculate VWAP for a 5-minute time frame for a short trade. first you need to calculate the typical price. Just calculate the sum of high, low and closing price of the candle and divide it by 3.

2. Now, multiply the typical price by total trading volume of the candle. You can refer to this value as n1.

3. Divide n1 value with the total trading volume till that time to find out volume-weighted average price if you want just a five minute trade.

4. You need to find n2, n3, and so on if you desire so. For that, just add all n values and divide them by the sum of volume values.

Although this explanation considers the time frame of five minutes, it does not mean you cannot use it, or it is useless for other time frames.

Uses of VWAP in Crypto Trading

Volume-Weighted Average Price is an indicator that falls in the category of technical analysis tools, so it works similarly to the moving average, relative strength index, etc. Some traders may use the price crossing the VWAP line as a signal to enter a trade. If the price breaches and goes above the VWAP, they may get into a long position. Conversely, if the price breaches and goes below the VWAP, they may get into a short position. So, traders mostly consider it bullish that the price of a coin has moved above the VWAP, and bearish that the price has dipped below.

In addition to being an indicator for entry and exit of trades, the VWAP may also be used to identify areas of liquidity. This can be especially useful for institutional traders looking to fill large orders. The indicator helps them determine ideal entry and exit points for large trades, which may decrease their market impact.

You can judge the efficiency of a trade by looking at the entry and exit points. If the entry point is below the VWAP line, the trade is good and has a lot of potential to give the trader good returns. Any entry above the line is unlikely to be profitable. Rather, it will most probably be in loss.

Risks and Demerits

One very important limitation of VWAP lies in its reduced effectiveness during highly volatile or news-driven market conditions. Sudden events such as macroeconomic announcements, regulatory news, exchange outages, or large liquidation cascades can cause abrupt price movements that invalidate previously established volume concentrations. In such situations, price may move aggressively away from the VWAP and fail to revert toward it, making the indicator unreliable as a reference point for entries or exits.

Although there is no technical barrier that hampers its use in long trades, VWAP is best suited for short-term trades. Its value comes out distorted if you apply for a trade that lasts more than a day. The reason is that of many days under consideration, on may have significantly higher volume. The heavy volume from one day can dominate the calculation and pull the VWAP toward prices that are no longer relevant to current market behavior, reducing its usefulness as a fair price benchmark.

Furthermore, it is a lagging indicator, so its effectiveness comes from historical price and volume data. Like other lagging indicators, its use in isolation may be risky. Leading indicators usually serve as signals for the trend to come, but lagging indicators are the signals of the trends that have already set in. Therefore, use it in combination with other TA indicators.

Conclusion

VWAP is a powerful yet simple technical indicator that helps traders understand the true average price of an asset by factoring in volume. When used correctly, it can improve trade timing, highlight liquidity zones, and offer valuable context for price action. However, like all lagging indicators, VWAP works best when combined with other technical tools and sound risk management, especially in the fast-moving and volatile crypto market.