Volume weighted average price (VWAP) is a useful tool for trading and investing. It shows, weighted by daily trading volume, a security’ average price. This clarifies for traders the reasonable worth of the security.
Intraday traders and institutional investors both use VWAP extensively in order to guide decisions. It helps companies monitor the success of large orders and direct traders on whether or not to open or close a deal.
This article will go over VWAP’s definition, computing technique, and justifications for application in trading strategies.
Also read: Mastering moving averages: A key indicator for trading success
What is VWAP?
Driven by trading volume, volume weighted average price (VWAP) is the average price a securities is traded at over a given period. VWAP is a more whole signal than basic averages since it considers volume as well as price.
VWAP usually guides traders towards the fair value of a security during a trading session. Traders can find whether a stock is underpriced, trading below VWAP, or overpriced by checking the current market price with the VWAP. Research on market trends and intraday trading depends on this indispensable instrument.
VWAP is not like moving averages like SMA (Simple Moving Average) and EMA (Exponential Moving Average). While SMA and EMA focus simply on price data over a chosen period, VWAP includes trading volume, providing a more realistic view of actual market activity.
VWAP is therefore particularly helpful for traders and institutions doing significant transactions since it guarantees that their transactions follow the general trend of the market.
You may also like: A Guide to Simple Moving Averages: Formula and Key Differences with EMA
How is VWAP calculated?
VWAP is calculated using a straightforward formula:
VWAP = Cumulative (Price Volume)Cumulative Volume
Components of the Formula:
- Price: The traded price of a security at each transaction.
- Volume: The number of shares traded in each transaction.
- Cumulative data: The total of all price × volume values and the cumulative trading volume over a given time frame.
Step-by-step example:
Let’s calculate VWAP for a security with three trades:
| Trade | Price (₹) | Volume (Shares) | Price × Volume (₹) |
| Trade 1 | 50 | 100 | 5,000 |
| Trade 2 | 52 | 200 | 10,400 |
| Trade 3 | 48 | 150 | 7,200 |
| 450 shares | ₹22,600 |
Let’s formulate now:
VWAP = ₹22,600450 = ₹50.22
This implies that throughout the period, the security’s volume-weighted average price is ₹50.22. VWAP allows traders to determine whether a security is trading above or below its average value, therefore guiding strategic decisions.
Key uses of VWAP in trading
Intraday trading
VWAP is a valuable tool for intraday traders timing their market entrance and exits. Common among traders is buying a stock when its price is less than the VWAP since it implies the stock is cheap with respect to its weighted average price. On the other hand, when the price seems excessive, selling above the VWAP is a typical approach.
If the VWAP for a stock is ₹100 and the current market price is ₹98, for instance, a trader may find a chance to purchase, expecting the price to either return to or exceed ₹100.
Must read: Intraday Trading Explained: How It Works and Its Benefits
Benchmark for institutions
VWAP serves as a benchmark for institutional investors evaluating the calibre of their trade execution. To reduce market impact, big buy or sell orders are sometimes split into smaller trades; institutions aim to execute trades as near to the VWAP as they can.
Getting a price close to VWAP shows good performance, thus preventing slippage or running expenses that are too expensive.
Trend identification
VWAP also lets traders spot trends and evaluate market mood. A stock trading above its VWAP shows a positive attitude and high buying power. On the other hand, a stock trading below VWAP shows a negative attitude and suggests that selling pressure rules.
A trader seeing a steady price movement above VWAP, for example, would interpret it as evidence of an uptrend and choose to either hold or buy. A consistent decline below VWAP could indicate a downtrend, which would call for caution or sales.
VWAP helps traders and investors see price movements, sentiment, and execution efficiency from another angle.
Advantages of VWAP
- Objectivity: By weighing price with trading volume, VWAP presents traders with an objective assessment of a security’s fair value. VWAP is a trustworthy source of reference for decision-making since it depends on accurate market statistics, unlike subjective measurements. It guarantees that when assessing market prospects, traders stay free from emotional prejudices.
- Easy to calculate: VWAP is extensively available and easy to calculate. Modern trading systems and analytical tools let even inexperienced traders include VWAP in their plans without depending on sophisticated software or advanced technical knowledge.
- Versatility: VWAP’s versatility among several asset types is one of its main strengths. VWAP is a flexible tool for many trading purposes since it performs well to offer insights on price fluctuations and market patterns, whether it comes to stocks, ETFs, or derivatives.
- Enhanced strategy: From short-term scalping to long-term investment plans, VWAP enables several trading techniques. Long-term traders can use it to guarantee the effective execution of bulk transactions; scalpers can use it to determine exact entry and exit locations. Its adaptability lets traders polish their strategies and raise their general effectiveness.
For traders hoping to make wise and successful trading decisions, VWAP is an indispensable instrument combining accuracy, simplicity of use, and adaptability.
Limitations of VWAP
- Intraday focus: Daily calculations of VWAP reset at the beginning of every trading session. For intraday trading this makes it quite successful; for long-term study it is less helpful. Those who concentrate on long timeframes could find it insufficient to follow patterns across more than one day.
- Lagging indicator: VWAP is naturally a trailing indicator since it depends on past data. It is less sensitive to abrupt changes in the market or price reversals since it reflects the average price and volume trends already experienced. In fast-moving markets where real-time changes are vital, this delay might be a disadvantage.
- Significant orders impact: Large buy or sell orders placed by institutional investors have a significant impact on trading volumes and, hence, VWAP computations. Particularly in low-volume sessions, this can distort the indicator and might not fairly represent the actual market attitude.
- Not predictive: VWAP is meant to compile previous performance rather than project future price changes. Although it offers a picture of the fair value of a security for the current session, traders should use it in concert with forward-looking indicators or tools to project market direction.
VWAP is nevertheless a valuable tool despite these constraints when utilised sensibly, especially in relation to other trading techniques and indicators.
Bottomline
For traders, VWAP is a necessary instrument for evaluating the fair value of an asset and guiding their actions during the trading day. For both new and seasoned traders, its capacity to spot trends, time entrances and exits, and its benchmark for institutional trades make it quite helpful.
To fully grasp VWAP’s applicability, it is advised to practise using demo accounts even before employing it in live markets. This practical knowledge will boost self-confidence and sharpen judgment.
Remember that VWAP offers insightful information, but creating a complete trading plan should be supplemented with other technical indicators and market analysis tools. This will help you to improve your trading success and equip you to negotiate market changes.
FAQs
Is the VWAP indicator accurate?
For evaluating a security’s fair value during a trading session, the VWAP indicator is often accurate. It uses both price and volume to offer an objective assessment. It is a trailing indicator, hence it might not react fast to abrupt movements in the market. For a complete trading strategy, it is most suited next to other technical indicators.
What is the VWAP rule?
The VWAP rule is the implementation of a trading benchmark produced from the volume weighted average price. Considering both price and volume helps traders ascertain the fair value of a security. To guarantee good transaction execution, traders may purchase below VWAP and sell above it. VWAP helps institutions minimise market effect and assess trade quality.
What does VWAP tell you?
Volume weighted average price indicates, over a given period, the average price of a securities weighted by volume. It guides traders in deciding a security’s fair value throughout a trading session. Trading over VWAP points to a positive trend; trading below points to a bearish trend. Trade execution quality is assessed and market entry and exits timed using VWAP.
Is VWAP bullish or bearish?
VWAP is not either optimistic or pessimistic by itself. It is the standard for reasonable value. Trading above VWAP, on the other hand, shows a positive trend implying high purchasing interest. Trading under VWAP, on the other hand, shows a bearish trend implying selling pressure. VWAP helps traders evaluate market mood and guide their decisions on entrances and exits depending on these tendencies.
Is VWAP better than EMA?
EMA and VWAP have separate uses. Useful for intraday trading and fair value assessment, VWAP offers an average price weighted by volume. Conversely, EMA responds to price changes and trends by giving more weight to recent prices, therefore reflecting this. Depending on their trading approach and objectives, traders sometimes combine both; neither is intrinsically better.
