Volume Weighted Average Price (VWAP) is the benchmark that institutional traders use to evaluate their execution quality. It represents the average price a stock has traded at throughout the day, weighted by volume. Because large funds measure their fills against VWAP, it naturally becomes a support and resistance level that retail traders can exploit.
The two primary VWAP signals are the green-to-red cross and the red-to-green cross. A green-to-red cross occurs when price falls below VWAP after trading above it, signaling a potential short entry. A red-to-green cross occurs when price rises above VWAP after trading below it, signaling a potential long entry. The strongest signals happen on the first or second cross of the day, as later crosses tend to indicate choppy, range-bound action.
Position sizing around VWAP should account for distance from the line. When price is close to VWAP, the risk/reward is favorable because your stop can be tight. As price extends further from VWAP, the probability of a mean-reversion move increases, but entering a new momentum position becomes riskier. A common approach is to scale position size inversely with distance from VWAP.
VWAP works best when combined with other levels. If a stock gaps up and the premarket high of day coincides with a VWAP reclaim, that confluence increases the probability of the trade. Conversely, if a stock is struggling at VWAP and also rejected at a premarket level, the short thesis becomes more compelling. VWAP is a tool, not a strategy in isolation.