# Understanding VWAP Algorithm for Financial Traders

In financial trading, the Volume Weighted Average Price (VWAP) is a popular algorithm used to assess the average price a security has traded at throughout the day, based on both volume and price. It is widely used by institutional traders to improve trade execution by ensuring that orders are executed in line with the market’s average price. However, while VWAP is a powerful tool, relying solely on it for trading decisions has its limitations. To gain a real edge, incorporating a news trading strategy offers a more robust and informed approach.

## The Significance of VWAP in Trading

VWAP represents the average price a security has traded at throughout the day, adjusted for the volume of trades at different prices. It provides traders with a benchmark to compare the current price against the day’s average trading price. The VWAP calculation is straightforward: it multiplies the price of each transaction by its volume, sums these values, and then divides by the total volume of trades.

## Historical Context and Insights

VWAP was first introduced in the 1980s as a way for institutional investors to measure the performance of their trades. It quickly gained popularity due to its simplicity and effectiveness in evaluating trade execution quality. VWAP became a standard benchmark for institutional trading, offering a fair representation of the average price paid for a security throughout the trading day.

One interesting insight about VWAP is its ability to reduce market impact costs. By targeting the VWAP, traders can minimize the price movements caused by large orders. This is particularly important for institutional traders who deal with substantial trade volumes. VWAP helps these traders execute large orders without significantly affecting the market price, ensuring more efficient and cost-effective trading.

Traders use VWAP for various reasons, including:

## VWAP in Action

To understand how VWAP is used in practice, let’s consider a hypothetical trading scenario. Suppose a trader is looking to buy a large quantity of stock XYZ throughout the trading day. By using VWAP, the trader can break up the large order into smaller chunks and execute them at prices close to the VWAP. This approach helps the trader achieve an average purchase price that is aligned with the market’s average, reducing the risk of overpaying for the stock.

## Limitations of Relying Solely on VWAP

While VWAP is a useful tool, it has limitations that traders should be aware of:

## A More Reliable Alternative: News Trading Strategy

Rather than relying solely on the VWAP, a more effective approach is to incorporate a news trading strategy. This strategy involves trading based on significant economic data releases, which can provide clearer and more immediate trading opportunities.

## Clear Edge with News Trading

News trading strategies offer a significant advantage, particularly when the market reacts strongly to deviations in key economic data. When an important economic report, such as GDP growth or employment figures, deviates from market expectations, it can result in substantial market movements. Traders who are prepared to react quickly to this new information can benefit from the ensuing volatility.

## Trading Strategy for Economic Data Releases

### Step 1: Analyze Central Bank Priorities

Understanding the current focus of central banks is crucial. If a central bank is closely monitoring a specific economic indicator, that indicator’s report will have a heightened impact on market volatility. Use a professional economic calendar, which includes a fundamental guide, to stay updated on the central bank’s priorities.

### Step 2: Use High-Low Expectation Forecasts

Professional traders use high-low forecasts to gauge market expectations accurately. Here’s a more detailed look at why these forecasts are essential:

### Understanding High-Low Forecasts

Economic forecasts are based on surveys from credible institutions, providing their best estimates on upcoming data points. Retail calendars typically present the median of these estimates, which can be misleading. The median forecast doesn’t reveal the full range of expectations and, therefore, doesn’t indicate how surprising an actual data release is compared to the extremes of analysts’ projections. In contrast, professional economic calendars include both high and low estimates. This additional information shows the analysts’ expectations at the extreme ends of their projections. Great trading opportunities arise when data releases fall outside these high and low estimates, creating market shocks that move prices significantly.

### Step 3: Choosing the Most Volatile Instrument to Trade

Using insights from institutional reports, traders can select the most responsive currency pairs or assets. For example, if the USD/JPY is particularly sensitive to economic data and a significant report shows a substantial deviation, this pair could be an ideal target for trading.

### Confirm Central Bank Focus

Ensure the central bank is currently emphasizing the economic data in question. If the central bank is focused on a specific data point, it’s because they are using that data point to make a decision on rates, leading to potential market volatility. This is the reason data points that are focused on cause volatility. Sometimes, the central bank is focused on a data point inside a data point. For example, the Federal Reserve has often highlighted average hourly earnings as the key metric within the Non-Farm Payroll report.

### Check Forecast Ranges

Before the data release, review the high and low forecast expectations for the event. Plan to trade only if the actual data significantly exceeds the high estimate or falls below the low estimate. This strategy ensures you act on genuinely surprising data and there will most likely be a follow-through reaction.

### Monitor Revisions

Check for any conflicting revisions in the data, as these can alter the initial market reaction. Make sure the primary release and any revisions align to support your trade.

Once you confirm the deviation, act quickly to enter your trade. Enter within the first 30 seconds. Speed is crucial, as market reactions to significant data surprises happen rapidly.

### After the Initial Run

Look for a shallow pullback around a 23% Fibonacci retracement or near support/resistance levels. This initial pullback can provide an opportunity to enter the trade again after taking a few points off the table from your first entry.

### Break Even

Move your stop-loss to break even as soon as possible to protect your gains. The stronger the release, the shallower the pullback. If the market doesn’t buy off your support/resistance level and continue to the highs of the one-minute candle, consider reassessing the trade.

### Reentries

If your initial position is stopped out at break even, consider reentering at deeper retracements, such as the 38% or 50% Fibonacci levels. Use nearby support and resistance levels to guide your reentry points.

## Conclusion

While VWAP is a valuable tool for assessing average trade prices and trend confirmation, its limitations make it less reliable for making standalone trading decisions. Instead, adopting a news trading strategy, such as the one detailed for economic data releases, can offer a more robust approach to trading in the Forex market. By following these steps, you’ll be well-prepared to trade economic data releases effectively, leveraging the same strategies that professional traders use to profit from these significant market events.