What Is VWAP – Volume-Weighted Average Price?
VWAP is a benchmark that is derived from the average share price ratio for a stock compared to the total share volume traded in a particular time frame. This measure helps analysts and investors evaluate the stock’s current price and determine if it is underpriced or overpriced compared to the average trading price on this day. Analysts often use this information to facilitate the exit or entry of a position.
Analysts use the VWAP as a benchmark for determining the quality of executions in large orders. For example, suppose a portfolio manager decides to accumulate thousands of shares and purchase the position less than the average price for the day. In that case, usually, the VWAP can be the price to beat. A trader aimed at acquiring a significant position might be considered successful based on a comparison between the VWAP and the average purchase price when the place was accumulated.
Understanding VWAP – Volume-Weighted Average Price
VWAP – Volume-Weighted Average Price is an intraday price measure used to help investors decide if they should adopt an active approach or a passive to position entries. It can also help make decisions on entering or exiting given security. Many traders and investors use the VWAP to buy at relatively low prices and sell at higher prices.
Calculating VWAP – Volume-weighted Average Price
Experts calculate the VWAP using the opening price per day and adjust in real-time until the session’s close. Therefore, the calculation takes and uses only intraday data. There is a formula for calculating VWAP:
VWAP = cumulative volume/Cumulative typical price x volume
The calculation starts with the Typical Price, which is the price of the candle or the first completed bar on the chart. It means that it depends on the time frame of the observed chart. For example, this could be the Typical Price of the first five-minute bar or candle on a five-minute chart. This price level is the low price, the average of the high price, and the candle’s closing price. You should consider the following example and use these pre-selected inputs:
[(H+L+C)/3], H = 44.54, L = 43.96 C = 44.28.
TP = (44.54+43.96+44.28) / 3 = 44.26
The next action in the VWAP calculation is the following: you need to multiply TP by the volume (V) in the measured period to find the Total Price Volume (TPV). If V = 35,000, then TPV calculates like this:
TPV = 44.26* 35000 = 1549000
The VWAP for the first candle becomes the Typical Price after the volume component leaves in the first part of the calculation. However, things are a little bit changed for the next candle. The formula calculates accumulated price and volume in the next procedure for the second candle and repeats for each subsequent candle after that:
TPV(Candle 1) + TPV (Candle 2]) / [V (Candle 1) + V (Candle 2)
Suppose we think that the second candle closed with a price of 43.97 and a volume of 32000. So, the volume production and the price for the second candle could be 1,406,730. You could add this amount to the TPV for the first candle. The VWAP keeps the running the price information and volume aggregated during the day to give the current VWAP in real-time. Therefore, to continue the example, the VWAP might be calculated by dividing the TPV by the cumulative volume of 68000. Therefore, the VWAP after the second candle could be obtained like this:
VWAP = 1549000 + 1406720 / 67000 = 44.11
This indicator can be calculated for any period to illustrate the VWAP for every data point in an intraday stock chart. This operation is done automatically by charting the algorithms of its platform. Thus, the user only needs to specify an intraday time frame in order to see the results of the VWAP calculation.
The Significance of VWAP
Because VWAP combines volume and price in its value, most analysts consider it more representative of the stock’s accurate average price. The calculation of the VWAP is deemed to be independent and does not affect the closing price.
Applying the VWAP
For the aforementioned reasons, most expert traders agree that the VWAP is valuable and influential while trading in short-term timeframes. These strategies might be buying the first closing price over VWAP as an entry and selling at a predetermined price. But more often, the strategy for trading is a bit more complex than that.
The reason for this event is the widespread opinion in professional and nonprofessional traders that institutional traders use the VWAP as a benchmark. Most of the traders believe that a recognition of this dynamic has to be pushed into a trading strategy.
As a result, a trader could use VWAP as a filter for their activity. They might go long only once the price is under the VWAP and short if the price is above VWAP. This filter can be based on the idea that benchmark-beating buyers might create support when the price is below VWAP. This filter could work well for relatively sideway price days.
By contrast, other trades may prefer the opposite tactic. Thus, they might assume entries for buying a stock could only occur when the price is above the VWAP, and short-selling thresholds could only be undertaken when the price is below it. This filter might be based on the opinion that benchmark watchers cannot get the price they want. They will always be forced to push the stock further into its trend for this day. This filter might work well for days with a well-defined trend for the day, whether it would be upward or downward.
Neither tactic of execution in a large number of trades holds a statistical edge. Therefore traders tend to combine their VWAP approaches with similar other indications. This strategy helps them work with a more profitable filter.
For example, a trader might also use the VWAP with Bollinger Bands. These are trendlines plotted positive and negative standard deviations away from a simple moving average of a security’s price.