Some intraday stock traders say that if they could choose only one technical indicator it would be the VWAP.
I find that VWAP is not necessarily a holy grail and traders disagree with the best way to use it. In the rest of this article, I test two very simple VWAP trading systems and present the results.
What is VWAP?
Very simply, VWAP stands for volume weighted average price and it gives an idea for the average price that investors have paid for a stock over the trading day.
It therefore gives an idea for how various investors are positioned.
Another reason for its popularity is that it’s often used by algos and institutional traders to scale into positions. Using VWAP, an algo can break up it’s position size into blocks so as to minimize its influence on the market.
Although investors naturally trade with different motives and timeframes the logic of how VWAP is used can lead to various types of trading systems.
1. Buy When Price Moves Above VWAP
According to some traders, the best time to buy a stock is when price crosses above VWAP. This is because it shows that buyers are in control.
If price is above VWAP then it could be said that the majority of intraday positions are in profit whereas if price is below VWAP it suggests that investors are likely losing money on their trades.
I wanted to test this out. So, the following strategy goes long when price crosses above VWAP on the 15-minute chart and sells when price crosses under VWAP. All entries and exits are made on the next bar open following the VWAP signal.
Following is an example of the trade we are looking for in SPY:
You can see SPY closes above the VWAP at 14:00 on Nov 28 so we go long on the next bar open at 14:15 (green arrow).
SPY closes below VWAP at 10 AM the next morning so we close our position on the next bar at 10:15 (red arrow). This gives us a 0.67% profit.
VWAP Trading System Results On SPY
Applying this VWAP trading system on SPY between 9/2012 – 1/2018 we get the following results:
- Net Profit (on $50k): $22,761.70
- Annualized Return (CAR): 7.39%
- Max Drawdown (MDD): -9.09%
- CAR/MDD: 0.81
- # Trades: 2598
- Win Rate: 27.33%
You can see that the strategy was profitable on SPY giving a total net profit of $22,762 from a sample of 2598 trades.
The compounded annual return is not particularly good but the maximum drawdown is small and so the CAR/MDD of 0.81 is decent. The win rate is particularly low at only 27%.
It should be mentioned that performance is also degraded by the inclusion of transaction costs, set at $0.005 per share.
2. Buy When Price Drops Below VWAP
Some traders use VWAP in the reverse way and look for a stock to drop below the VWAP line.
These traders see VWAP as a guide to value and feel that when a stock trades under VWAP then it indicates good value and should be bought.
The following strategy, therefore, goes long when price crosses below VWAP on the 5-minute chart and it sells when price crosses back above VWAP.
Since there are many algos that use VWAP to scale in trades this seems like it could be a solid trading idea so let’s test it out.
Following is an example of the trade setup:
SPY closes below VWAP on the 5-minute chart at 12:00 so we go long the next open at 12:05. We don’t exit the trade until the next morning at 09:40. We suffer an intraday drawdown but end in a decent profit.
Backtesting this strategy on SPY between 9/2012 – 1/2018 gives the following result:
- Net Profit (on $50k): $1,078.36
- CAR: 0.41%
- MDD: -24.79%
- CAR/MDD: 0.02
- # Trades: 2599
- Win Rate: 79.57%
What is interesting about these results is that we have recorded a much higher win rate (almost 80%) yet we have a much worse result and an unattractive looking equity curve.
So far it seems that VWAP works better for momentum than for mean reversion.
Results For 20 Nasdaq Stocks
So far we have seen some mixed results when trading SPY intraday using VWAP. How does the indicator get on when trading other tickers?
To find out, I picked 20 Nasdaq stocks at random and applied the two strategies above to each one.
This time, I extended the data period – 1/2008 – 1/2018 and I tested three different time frames; the 5-minute chart, 15-minute chart and the 2-hour chart.
Following you will find summaries of the results:
Results – Strategy 1 (Buy When Price Moves Above VWAP)
Results – Strategy 2 (Buy When Price Moves Below VWAP)
So what can we make of these results?
Well, it’s clear that VWAP is not a holy grail in this simple form but it is capable of some good results.
Using VWAP to trade momentum worked great for Amazon giving us a 20.45% annualised return on the 15-minute chart despite only a quarter of trades being winners.
It worked even better on the 2-hour chart with half of the 20 stocks showing a profit.
Conversely, using VWAP for mean reversion worked well for KRFT giving an annualised return of 33% on the 15-minute chart with minimum drawdown. But only six stocks were profitable on this timeframe.
Overall, it seems that momentum works best for VWAP and the longer 2-hour chart has the best results.
Interestingly, you will find that most intraday stock traders are looking at much lower time frames than that. The superiors results here are surely a reflection of the impact of transactions costs on shorter time frames.
So, using VWAP to trade momentum on the 2-hour chart worked best. But it must be said that none of the strategies were consistently profitable. Several of the stocks tested sustained deep losses.
VWAP is a very popular indicator among stock traders and you can understand why. It is an intuitive indicator and forms the basis of many execution strategies.
However, research online reveals that intraday stock traders disagree on the best way to use it.
This suggests that the indicator is not a holy grail and can be used in different ways depending on the market, the time frame and the trend.
Our results reveal a similar conclusion.
Using VWAP can result in strong profits but much depends on the symbol and whether the market is trending or ranging.
It’s also worth mentioning that transaction costs, as with any intraday strategy, play a large role in expected returns.
Clearly, there are many other ways to incorporate VWAP into a trading strategy. I am looking at several ideas and not found anything conclusive yet.
What this analysis does show is that it is unwise to jump into a VWAP trading strategy that you read about online until you have fully understood the dynamics and expectancy of the system (or lack of!).
Using VWAP on longer term charts works better because it reduces the impact of costs.
If you are interested in more trading strategies, system ideas and education, make sure to check out our full program at Marwood Research.
Simulations and charts from Amibroker using intraday data from DTN IQ Feed. Results include transaction costs of $0.005 per share each side.
Please remember, financial trading is risky. Mistakes and errors do occur especially with intraday data. Please read the full Disclaimer.