Volume Weighted Moving Average: How to trade it like a PRO

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When the market makes a move on volume, this means that a price break-out is confirmed by a simultaneous rise in volume. Volume means strength.
The stronger volume moves up, the more buyers are behind that move.

I found it very helpful to use the Volume Weighted Moving Average, VWMA. This is a tool you can use to combine both a moving average and volume in order to get a read on momentum and breakout strength – the volume weighted moving average. What it does is to incorporate not only the last x periods of price into its calculation but also the average volume during those periods. That means:

When the volume is stronger, the VWMA will follow price more closely, and when volume falls off, it will mimic a simple moving average.

Important: As you know I use a 50 period Standard Moving Average (SMA50). So I also add an 50 period Volume Weighted MA to it. And when the VWMA(50) is between price and the SMA(50), then volume confirms we are trending in that direction.

Look at the example below, I just came by. At the exact moment all my indicators confirmed the entry, the VWMA was well above the SMA already, showing us that volume confirms the uptrend. The retrace at the second arrow even bounced off of the VWMA instead of the SMA as support, nice example.

(SMA = green line and VWMA = magenta line)

So this is how I use the VWMA:

  • When price goes up, and SMA turns up, I will check if VWMA is between price and SMA on entry. That should confirm the trend has strength.
  • Reversely, when price goes up, but VWMA goes down or below SMA, this is a “divergence” between price and volume. A divergence means price (trend) is losing confirmation by volume. It is often a signal that the trend will be over (soon).

 

In this next example below, price started a VERY early uptrend, even stayed above the SMA for some time (consolidation / inside-bar kind of pattern), but failed to close above the close of the initial big green candle (that broke above the SMA).
All that time the VWMA remained below SMA, showing us a divergence between price and volume. And subsequently price lost its strength and fell below the SMA as well.

 

So you don’t want to enter a trend, we want to enter a STRONG trend:  Confirmed by volume. VWMA seems to be able to do this, it’s a perfect addition to my toolset.

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