Why does the VWAP work

So I’m a big believer in knowing why a trade will or should work.

Who is on the other side of my trade and why should price move higher after I’ve bought it.

That might sound ridiculous, but I like to know the reasons behind a specific pattern or setup working.

I can’t just risk capital on pretty patterns on a screen, I need to know the story or theme behind the play.

eg:

Trapped shorts – makes sense why price would drive higher.

Trend pullback – I understand the nature of a trend and the feelings when it pulls back for the first time.

Which brings me to the VWAP.

VWAP is the Volume Weighted Average Price

I’ve banged on about it for years (check out this article where I dig into some VWAP trading strategies.)

Now, I believe the VWAP works because it’s the benchmark for institutions and algorithms across the world.

So, as price starts to approach VWAP after trending higher, algos looking to get a large order filled over a period of time start to become more aggressive and start to potentially lift offers, rather than just resting on the bid.

I discuss more about that concept and algos here in my recent podcast episode.

Traders configuring VWAP-based algos also have the ability to make adjustments depending on how price vs time-sensitive they are.

Check out the parameters you can adjust with Interactive Brokers (this is a broker for both retail and institutions but it gives us some idea as to what the bigger players are working with.)