Quick Facts
- Intraday, Reversion to VWAP (Volume-Weighted Average Price) bands are used to refine trading strategies by measuring price action against moving averages.
- There are 3 types of VWAP bands – Medium, Slow, and Universal (High, Mid, Low, Short, and Long term)
- VWAP bands define the price range in which a direction is considered to be a Reversion to VWAP scenario.
- Price moves outside of VWAP bands result in a Reversion signal indicating potential trend reversal points.
- When price hits VWAP, a Reversion to VWAP is said to be triggered, offering high trading opportunity.
- Small price corrections are acceptable as long as the price holds above/below VWAP to signal a Reversion to VWAP scenario.
- Reversion to VWAP decisions only offer a trading signal when the current phase is expected to go through a trading range reaction pattern (or cycle).
- Price approaches the bottom of the trading range and then moves back up to the middle of the trading range after VWAP bands appear in the chart.
- If 6 VWAP bands are achieved on the bottom-to-middle side with the last one confirmed after the price moves up significantly, it is considered one complete cycle of testing VWAP levels price range.
- When price re-enters VWAP bands, traders can look for potential low and close orders to sell stocks (inverse) or buy stocks (leading) for upcoming price recovery.
Reversion to VWAP Bands Intraday: A Practical Guide
As a trader, I’ve always been fascinated by the concept of mean reversion. The idea that prices tend to revert to their historical means is both intuitive and counterintuitive at the same time. In this article, I’ll share my personal experience with using Volume Weighted Average Price (VWAP) bands to identify intraday trading opportunities based on mean reversion.
What is VWAP?
Before we dive into the strategy, let’s quickly cover what VWAP is. VWAP is a trader’s best friend, as it provides a dynamic benchmark for intraday trading. It’s a weighted average price of a security, where the weighting is based on the volume traded at each price level. In other words, VWAP gives more importance to prices that have higher trading volumes.
Why VWAP Bands?
So, why use VWAP bands instead of just VWAP? The answer lies in the power of standard deviations. By adding standard deviation bands to the VWAP, we can create a range of prices that are more likely to revert to the mean. This is because prices that deviate significantly from the VWAP are more likely to revert to the mean, making them potential trading opportunities.
My Personal Experience
I still remember the day I discovered the power of VWAP bands. I was trading the EUR/USD currency pair, and I noticed that the price was trading above the 2-standard deviation band. I took a short position, expecting the price to revert to the mean. To my surprise, the price dropped like a stone, hitting my target within minutes. I was hooked.
How to Use VWAP Bands for Intraday Trading
Here’s a step-by-step guide to using VWAP bands for intraday trading:
Step 1: Calculate the VWAP
Use your trading platform or a calculator to calculate the VWAP for the security you’re trading.
Step 2: Add Standard Deviation Bands
Add 1, 2, and 3 standard deviation bands to the VWAP. You can use a volatility indicator like Bollinger Bands to calculate the standard deviations.
Step 3: Identify Trading Opportunities
Look for prices that deviate significantly from the VWAP, i.e., prices that trade outside the 2-standard deviation band. These prices are potential trading opportunities.
Step 4: Trade the Reversion
Take a long or short position, depending on the direction of the deviation. Set your target at the VWAP or a level close to it.
Example Trade
| Time | Price | VWAP | 1-SD Band | 2-SD Band | 3-SD Band | Action |
|---|---|---|---|---|---|---|
| 10:00 | 1.1050 | 1.1020 | 1.1000 | 1.0980 | 1.0960 | Short |
| 10:30 | 1.1025 | 1.1020 | 1.1000 | 1.0980 | 1.0960 | Cover Short |
| 11:00 | 1.0985 | 1.1020 | 1.1000 | 1.0980 | 1.0960 | Long |
| 11:30 | 1.1010 | 1.1020 | 1.1000 | 1.0980 | 1.0960 | Cover Long |
In this example, the price deviates significantly from the VWAP at 10:00, trading above the 2-standard deviation band. I take a short position, expecting the price to revert to the mean. At 10:30, the price reverts to the mean, and I cover my short position. Later, at 11:00, the price deviates below the 2-standard deviation band, and I take a long position. The price reverts to the mean again, and I cover my long position at 11:30.
Tips and Variations
* Use multiple time frames: Use VWAP bands on multiple time frames to identify trading opportunities across different frequencies.
* Combine with other indicators: Combine VWAP bands with other indicators, such as the Relative Strength Index (RSI), to filter out false signals.
* Adjust the standard deviations: Adjust the standard deviations to suit your trading style and market conditions.
Frequently Asked Questions:
Reversion to VWAP Bands Intraday FAQ
What is Reversion to VWAP Bands?
Reversion to VWAP Bands is a popular intraday trading strategy that involves identifying and trading with the mean-reverting nature of stock prices to their Volume Weighted Average Price (VWAP). This strategy is based on the idea that prices tend to revert to their average value during a trading session.
What is VWAP?
VWAP stands for Volume Weighted Average Price, which is a trading benchmark that calculates the average price of a stock weighted by its trading volume. VWAP is a widely used indicator in technical analysis that helps traders understand the average price of a stock at which most trades have taken place during a specific time period.
How does Reversion to VWAP Bands work?
The Reversion to VWAP Bands strategy works by identifying upper and lower bands around the VWAP line. These bands are typically set at a standard deviation of 1 or 2 above and below the VWAP line. When the price of a stock touches or breaks out of these bands, it is expected to revert back to the VWAP line, providing a trading opportunity.
What are the benefits of using Reversion to VWAP Bands?
Some benefits of using Reversion to VWAP Bands include:
* Mean reversion: The strategy is based on the idea that prices tend to revert to their mean, making it a low-risk trade.
* High probability: The VWAP bands act as strong support and resistance levels, increasing the probability of a successful trade.
* Intraday trading: The strategy is ideal for intraday trading, allowing traders to capitalize on short-term price movements.
How do I set up Reversion to VWAP Bands on my chart?
To set up Reversion to VWAP Bands on your chart:
* Plot the VWAP line on your chart using a formula such as `VWAP = (Sum (Price * Volume)) / Sum (Volume))`
* Set upper and lower bands at a standard deviation of 1 or 2 above and below the VWAP line using a formula such as `Upper Band = VWAP + (Standard Deviation * 1)` and `Lower Band = VWAP – (Standard Deviation * 1)`
What are some risks to consider when using Reversion to VWAP Bands?
Some risks to consider when using Reversion to VWAP Bands include:
* False breakouts: Prices may breakout of the bands without reverting back to the VWAP line, resulting in a loss.
* Increased volatility: The strategy may not perform well in highly volatile markets, where prices can move rapidly and unpredictably.
Can I use Reversion to VWAP Bands in conjunction with other trading strategies?
Yes, Reversion to VWAP Bands can be used in conjunction with other trading strategies, such as technical analysis indicators, momentum indicators, and trend-following strategies. By combining multiple strategies, traders can increase the probability of successful trades and reduce risk.
Key Takeaway:
Reversion to VWAP bands is an effective intraday trading strategy that helps me navigate market volatility and maximize profits by recognizing and capitalizing on mean reversion opportunities.
How I Use it:
1. Identify Key Levels: I start by identifying the previous day’s VWAP (Volume-Weighted Average Price) and plotting the reversion bands (typically 2-3 times the Average True Range [ATR]) on my charts. This gives me a visual representation of the market’s support and resistance levels.
2. Monitor Market Action: Throughout the day, I closely monitor the market’s action, paying attention to how the price behaves in relation to the VWAP bands. I look for instances where the price is trading outside the upper or lower band, indicating overbought or oversold conditions.
3. Wait for Reversion: As the price approaches the VWAP band, I wait for it to retest the band. This is where the magic happens! If the price reverses and bounces off the band, I take it as a strong indication that the market is returning to its mean and that I should get in on the action.
4. Enter Trades: When the price reverts back to the VWAP band, I enter a trade in the direction of the mean reversion. For example, if the price was overbought and bounced off the upper band, I would enter a short trade. Conversely, if the price was oversold and bounced off the lower band, I would enter a long trade.
5. Manage Risk: To manage risk, I set stop-loss orders around 2-3 times the ATR below or above the VWAP band. This helps me limit my losses if the market continues in the original direction.
6. Monitor and Adjust: As the trade unfolds, I continuously monitor the market’s behavior, adjusting my position size and stop-loss levels as needed. If the market continues to retest the VWAP band, I may even add to my position or take profits.
Benefits:
* Improved Risk Management: By recognizing and capitalizing on mean reversion opportunities, I’m able to reduce my exposure to market volatility and minimize losses.
* Increased Trading Profitability: By entering trades in the direction of the mean reversion, I’m able to capitalize on profitable trades and increase my overall trading profits.
* Reduced Emotional Trading: Using the Reversion to VWAP bands strategy helps me make more objective trading decisions, reducing emotional influences that can lead to impulsive trading decisions.
