Volume-weighted average price (VWAP) is an important tool that traders use to track the average price of a security over a certain period of time. Typically, traders and analysts use the standard VWAP, which calculates the price based on all of the orders for the trading day; however, some prefer to use multiple time frames for the VWAP.
Traders and analysts use the VWAP to eliminate the noise that occurs throughout the day, so they can gauge what prices buyers and sellers are really trading at on the stock or the market. VWAP gives traders insight into how a stock trades for that day and determines, for some, a good price at which to buy or sell.
There is a natural selling pressure when a stock is trying to break above or below the VWAP. When a stock or the market tries to break above or below the VWAP line or a VWAP cross, there is usually a battle between buyers and sellers. If a stock tries to break above or below the VWAP level multiple times throughout the day, traders and analysts can see that it is a good price to either buy or sell. However, some short-term traders like to wait for one side to lose the battle and either go long on a break above the VWAP or short on a break below the VWAP.
The VWAP can also help traders and analysts gain insight into where the momentum is at a specific time frame. For example, assume a trader was short a stock because there was constant selling pressure and the stock failed to break above the VWAP multiple times. If the stock reverses and has a clean breakout above the VWAP, the trader should look to cover the short because they may be on the wrong side of the trade; the momentum has shifted to the buy side because the sellers have let up.