As with sailing, traders make an implicit assumption: the environment that has characterized the recent past will continue into the immediate future. This is true whether we are anticipating trend continuation or the continuation of cycles/reversals. Tools that provide unique information regarding recent regimes are useful weather vanes for guiding trades going forward.
At the recent Trade Ideas conference in San Diego, I was impressed with the VWAP tools introduced by Brian Shannon of Alphatrends. Volume-weighted average price (VWAP) is a way of tracking the behavior a market or stock by placing the greatest weight on the prices that transact the greatest volume. It's a true weather vane, telling us if we are staying consistently above or below VWAP or if we are cycling around an average price. It also tells us if that average price is rising or falling--and if the rate of rising/falling (slope) is changing.
Brian makes creative use of VWAP in two ways:
* By anchoring the calculation of VWAP to key price levels, such as points of breakout or points of earnings releases (see here).
* By looking at VWAP at multiple time frames, to identify degree of convergence and divergence among the VWAP values (see here).
If we think of it, the convergence of VWAPs across time frames is a nice way of visualizing the volatility of a market and anticipating possible breakouts. The anchoring of VWAP tells us if a key level is truly acting as a key level: for example, if a gap higher is truly leading to a trend.
The larger idea here is to continually grow your trading resources. Physicians engage in continuing education; they keep up with new ideas and techniques. Similarly, it's not enough for us to learn as beginning traders: we must continually learn and relearn to adapt to an ever-changing market landscape.
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