What Is the Volume-Weighted Average Price (VWAP)?
The Volume-Weighted Average Price (VWAP) is a key intraday trading indicator that resets at the start of each trading session. It calculates the average price of a security by factoring in both volume and price, offering insights into market trends and fair value.
Key Takeaways
- VWAP appears as a smooth line on intraday charts, resembling a moving average.
- It helps traders gauge intraday price trends and liquidity.
- Primarily used by short-term traders as a trading benchmark.
- Institutional investors leverage VWAP to minimize market impact during large trades.
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Understanding VWAP
VWAP is derived by summing the dollar value of all trades (price × volume) and dividing by the total shares traded. The formula is:
VWAP = (Cumulative (Price × Volume)) / Total Volume
Simplified Calculation
Most charting platforms approximate VWAP using:
- Typical Price = (High + Low + Close) / 3
- Multiply by volume for each period.
- Divide cumulative total by cumulative volume.
Step-by-Step Manual Calculation
- Intraday Periods: Use 5-minute intervals.
- Average Price: (High + Low + Close) / 3 for each period.
- PV: Multiply average price by volume.
- Cumulative PV: Sum PV values throughout the day.
- VWAP: Divide cumulative PV by cumulative volume.
How Traders Use VWAP
- Trend Confirmation: Prices above VWAP signal strength; below suggests weakness.
- Entry/Exit Points: Buy below VWAP; sell above.
- Institutional Strategy: Large orders are executed near VWAP to reduce slippage.
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VWAP vs. Simple Moving Average (SMA)
| Feature | VWAP | SMA |
|---|---|---|
| Calculation | Price × Volume / Total Volume | Average of closing prices |
| Volume Sensitivity | Yes | No |
| Usage | Intraday trends | Long-term trends |
Limitations of VWAP
- Single-Day Focus: Resets daily; multi-day averages distort accuracy.
- Lagging Nature: Relies on historical data, not predictive.
- Trend Weakness: In strong trends, prices may not revert to VWAP.
FAQs About VWAP
Q: How does VWAP differ from TWAP?
A: VWAP factors in volume, while Time-Weighted Average Price (TWAP) averages prices over time, ignoring volume.
Q: Can VWAP predict future prices?
A: No—it’s a lagging indicator based on past data.
Q: Why do institutions prefer VWAP?
A: It helps execute large orders without drastically moving prices.
Q: Is VWAP suitable for all trading styles?
A: Best for intraday traders; less useful for long-term investors.
Q: How reliable is VWAP in volatile markets?
A: Accuracy may decline during extreme volatility due to rapid volume shifts.
The Bottom Line
VWAP is a powerful tool for intraday traders, blending price and volume to reveal fair value. Use it alongside other indicators for robust trading decisions.