In this article we will use a rather known indicator in the world of trading: VWAP. Acronym for volume Weighted Average Price, the VWAP, represents the average weighted price for the volumes exchanged.
To test some simple operational ideas based on this indicator, we will take the future on Nasdaq as a reference, one of the most used tools by those who work on the financial markets with systematic logic.
The Future on the Nasdaq is listed on the CME of Chicago and has a daily session that opens at 17:00 and ends at 16:00 on the next day (Chicago timetable). However, for the purposes of this analysis we will focus exclusively on the cash session, the one that most faithfully replies the typical operation of the American stock market. The cash session for Nasdaq goes from 8:30 to 15:00 (Chicago time), corresponding to 15:30 – 22:00 Italian hours.
Just to work directly on this temporal window, we will use the @nq.d contract, which represents the filtered version of the future Nasdaq and takes into account exclusively data relating to the cash session.
During the analysis we will apply objective rules, in order to evaluate the behavior of the indicator on concrete and replicable bases.
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VWAP in intraday trading: what it is and how it works
Vwap is an indicator that takes into account two fundamental variables: the price and the volume.
Its calculation takes place by adding, for each bar, the product between the price and the volume, and then divide by the total of the volumes exchanged up to that moment.
In practice, the VWAP provides the weighted average price for the volumes exchanged up to that moment of the session. Precisely because of this “cumulative” nature, the VWAP tends to move much more slowly than the price, and often acts as a sort of balance point around which the market can oscillate.
It is often said that VWAP is an indicator widely observed by institutional operators, used as a reference to evaluate the quality of executions or as a psychological level of intraday support and resistance.
Figure 1 shows a visual example of the functioning of the VWAP during a trading session.
Figure 1. Graphic representation of the VWAP trading indicator.
Long strategy with VWAP on the future of Nasdaq: rules and operational setup
To test the behavior of the VWAP we will develop a long -term strategy only with the long -term upward trend that historically characterizes the American stock market, and in particular the Nasdaq index. We will work on a 30 -minute time frame, so as to have an intraday view sufficiently detailed without going into too fast frames.
Considering that the VWAP could represent a potential level of support or resistance, we will open a long position if a 30 -minute bar close above the value of the VWAP calculated up to that moment.
To allow the VWAP to build on a sufficient amount of data, we will begin to consider entrances starting from an hour after opening the cash session, or from 9:30 in Chicago forward.
We will limit the number of inputs to a single trade per day, to avoid operating too often and maintain the strategy simple and well controllable.
To manage the risk, we will apply a stop loss and a take profit both set at $ 2,500 per contract. This will also allow us to eliminate any particularly favorable or unfavorable outliers, giving greater stability to the results.
Finally, if the stop loss or the take profit were not affected during the day, we will still close the position at the end of the session, thus maintaining an exclusively intraday operations.
Figure 2 shows a visual example of a trade generated according to this operational logic.
Figure 2. Example of trade using the VWAP indicator.
VWAP strategy tested over 14 years of data: this is how it behaved
To evaluate the behavior of the strategy, we have analyzed the results from 2010 to the present day, so as to cover a large time sample and observe the evolution of logic on different market phases.
As can be observed from Equity Line in Figure 3, the system shows a rather regular growth over the years and without particular phases of DrawDown.
From the Total Trade Analysis (Figure 4) we note that a total of 2751 trades were performed, all exclusively long, as required by the operational logic.
However, the value of the winning trade is unfortunately quite low, reaching about 51 dollars per operation. A value that, as we know, would hardly be able to bear any operating costs (commissions and slips) in the case of use in Real.
Despite this, the general behavior of the strategy remains interesting, especially as a starting point for further insights and developments.
Figure 3. Equity Line of the strategy based on the VWAP indicator applied to Nasdaq.
Figure 4. Total trade analysis of the strategy based on the VWAP indicator applied to Nasdaq.
How to improve the efficiency of the strategy by limiting the operating window
As the operational logic is structured, the strategy can generate signals even in the last minutes of the cash session. In these cases, late inputs may be less efficient, as the residual time available for the development of the trade becomes very limited.
For this reason, we decided to introduce optimization on the operating window through an input called “Myndtime”, which defines the maximum time within which to consider any entry signals.
In other words, we will continue to take the signals starting from 9:30 in Chicago (as already established), but we will limit the possibility of opening positions only up to a certain time, beyond which the signals will no longer be considered valid.
Figure 5 shows the results of this optimization: it can be observed how, progressively restricting the time window, rather evident improvements are obtained on the main performance parameters.
In light of these results, we will therefore proceed by choosing the period between 9:30 and 11:00 (Chicago Time) as the new operating window.
Figure 5
Improved results with a reduced operating window
After restricting the operating window, we can analyze the updated results of the strategy. Figure 6 shows the new Equity Line, which continues to maintain a growing and regular trend over the years.
Observing the Total Trade Analysis in Figure 7, we notice how the total number of trade descended to 1564 operations, precisely due to the restriction on the time window.
The most interesting aspect, however, concerns the value of the warning trade. With this new configuration, the Averrage Trade has risen to 98.12 dollars per trade, practically double the previous value that stood at a short time above 51 dollars.
Ultimately, limiting the temporal input window has made it possible to eliminate some less efficient trades that took place in the final stages of the session, leaving room for the more directional movements that evidently start in the first part of the day.
Figure 6. Equity Line of the VWAP strategy on Nasdaq with restricted window.
Figure 7. Total trade analysis of the VWAP strategy on the Nasdaq with restricted window.
Conclusions: the VWAP indicator as a basis for creating systematic strategies
Of course, the system presented could be further refined, for example by working on a more accurate optimization of the Stop Loss and Take Profit levels, or by evaluating any additional filters.
Having said that, we cannot know with certainty how VWAP is really monitored by institutional operators or how much weight is actually attributed to this indicator in their operational logic. However, through this article we have seen how, by applying simple and objective rules, it is possible to exploit the VWAP to identify interesting entrance points on a very liquid and volatile tool such as the Nasdaq.
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Until next time,
Andrea Unger