Volume-Weighted Average Price (VWAP)

What Is the Volume-Weighted Average Price (VWAP)?

The volume-weighted average price (VWAP) is a trading benchmark used by traders that gives the average price a security has traded at throughout the day, based on both volume and price.

VWAP is important because it provides traders with insight into both the trend and value of a security.

Key Takeaways

  • The volume-weighted average price (VWAP) appears as a single line on intraday charts (1 minute, 15 minute, and so on), similar to how a moving average looks.
  • Retail and professional traders may use the VWAP as part of their trading rules for determining intraday trends.

Volume Weighted Average Price

Volume-Weighted Average Price Formula

VWAP is calculated by adding up the dollars traded for every transaction (price multiplied by the number of shares traded) and then dividing by the total shares traded.

 VWAP = Price * Volume Volume \text{VWAP}=\frac{\sum\text{Price * Volume}}{\sum\text{Volume}} VWAP=VolumePrice * Volume

How to Calculate the Volume-Weighted Average Price

Adding the VWAP indicator to a chart will complete all calculations for you. To calculate the VWAP yourself, follow these steps. Assume a 5-minute chart; the calculation is the same regardless of what intraday time frame is used.

  1. Find the average price the stock traded at over the first 5-minute period of the day. To do this, add the high, low, and close, then divide by three. Multiply this by the volume for that period. Record the result in a spreadsheet, under column PV.
  2. Divide PV by the volume for that period. This will give the VWAP value.
  3. To maintain the VWAP value throughout the day, continue to add the PV value from each period to the prior values. Divide this total by total volume up to that point. To make this easier in a spreadsheet, create columns for cumulative PV and cumulative volume. Both these cumulative values are divided by each other to produce VWAP.

What Does VWAP Tell You?

Large institutional buyers and mutual funds use the VWAP ratio to help move into or out of stocks with as small of a market impact as possible. Therefore, when possible, institutions will try to buy below the VWAP, or sell above it. This way their actions push the price back toward the average, instead of away from it.

Traders may use VWAP as a trend confirmation tool, and build trading rules around it. For example, when the price is above VWAP, they may prefer to initiate long positions. When the price is below VWAP they may prefer to initiate short positions.

The Difference Between VWAP and a Simple Moving Average

On a chart, VWAP and a moving average may look similar. These two indicators are calculating different things.

VWAP is calculating the sum of price multiplied by volume, divided by total volume.

A simple moving average is calculated by summing up closing prices over a certain period (say 10) and then dividing it by how many periods there are (10). Volume is not factored in.

Limitations of Using the Volume-Weighted Average Price

VWAP is a single-day indicator and is restarted at the open of each new trading day. Attempting to create an average VWAP over many days could mean that the average becomes distorted from the true VWAP reading as described above.

While some institutions may prefer to buy when the price of a security is below the VWAP, or sell when it is above, VWAP is not the only factor to consider. In strong uptrends, the price may continue to move higher for many days without dropping below the VWAP at all or only occasionally. Therefore, waiting for the price to fall below VWAP could mean a missed opportunity if prices are rising quickly.

VWAP is based on historical values and does not inherently have predictive qualities or calculations. Because VWAP is anchored to the opening price range of the day, the indicator increases its lag as the day goes on. This can be seen in the way a 1-minute period VWAP calculation after 330 minutes (the length of a typical trading session) will often resemble a 390-minute moving average at the end of the trading day.

What Is the Volume-Weighted Average Price (VWAP)?

The volume-weighted average price (VWAP) is a measurement that shows the average price of a security, adjusted for its volume. It is calculated by taking the total dollar value of trading in the security and dividing it by the volume of trades during that period. Specifically, the formula for calculating VWAP is as follows:

VWAP=Price * VolumeVolume\text{VWAP}=\frac{\sum\text{Price * Volume}}{\sum\text{Volume}}VWAP=VolumePrice * Volume

Why Is the Volume-Weighted Average Price (VWAP) Important?

The VWAP is used by traders who wish to see a smoothed-out indication of a security’s price over time. It is also used by larger traders who need to ensure that their trades do not move the price of the security they are trying to buy or sell.

For example, a hedge fund might refrain from submitting a buy order for a price above the security’s VWAP, in order to avoid artificially inflating the price of that security. Likewise, it might avoid submitting orders too far below the VWAP, so that the price is not dragged down by its sale.

What Is the Difference Between the Volume-Weighted Average Price (VWAP) and a Simple Moving Average?

Like the VWAP, the simple moving average provides traders with a less volatile view of the recent price trend of a security. Unlike the VWAP, however, the simple moving average does not take into account the level of volume in that security’s trading. This is because the VWAP weights each day’s price change by the amount of volume occurring in that day, whereas the simple moving average implicitly assumes that all trading days have the same level of volume.