VWAP stands for Volume Weighted Average Price. It is a trading indicator that represents the average price a security has traded at throughout the day, weighted by volume. VWAP is used by traders to assess the average price of an asset over a specified time period, which typically covers the entire trading day. VWAP is commonly used by institutional traders, day traders, and algorithmic traders to measure the efficiency of their trades and determine the optimal execution price.
VWAP is calculated by taking the total value traded (price × volume) at each point throughout the day and dividing it by the total volume traded. The formula for VWAP is:
Price is the price of the asset at each transaction. Volume is the volume of trades at that price.
Intraday Indicator: VWAP is primarily used within the context of a single trading day and resets at the beginning of each new trading session. Volume-Weighted: Unlike simple moving averages (SMA), which treat every price point equally, VWAP gives more weight to prices at times of higher trading volume. This means VWAP reacts more sensitively to periods of heavy trading. Trend Confirmation: VWAP is a great tool for understanding the direction of the market, as it moves with price and volume. Prices above VWAP indicate a potential uptrend, while prices below VWAP suggest a downtrend.
Traders use VWAP as a reference point to judge whether the current price is above or below the average price of the day. If a stock is trading above VWAP, it suggests that buyers are in control and the stock might be in an uptrend. If it’s below VWAP, it indicates that sellers dominate the market.
VWAP can act as dynamic support or resistance. If the price approaches VWAP from below, it may act as resistance. Conversely, if the price approaches VWAP from above, it may act as support.
Traders often use VWAP for determining entry and exit points. For example:
Buy Signal: If the price crosses above the VWAP and stays there, it may indicate a buy signal. Sell Signal: If the price drops below the VWAP, it could be a signal to sell or short.
Institutional investors often aim to buy below VWAP and sell above VWAP to minimize market impact. VWAP is commonly used by these traders to execute large trades without moving the market too much.
Traders may use short-term moving averages (e.g., 5-period or 10-period moving averages) in conjunction with VWAP to identify crossovers. A crossover of the price above the VWAP could suggest a trend change, just as crossing below could signal a reversal.
Differences Between VWAP and Moving Averages:
While both VWAP and SMAs average prices, VWAP is volume-weighted, meaning it accounts for the volume of trades at each price. This makes VWAP more responsive to high-volume price movements than SMA, which treats each price point equally.
VWAP differs from EMA because EMA gives more weight to recent prices but does not factor in volume, while VWAP’s primary focus is on price and volume for each trade.
Accurate Reflection of Market Sentiment: Because it’s volume-weighted, VWAP gives a more accurate picture of where the majority of trades are occurring and helps traders gauge market sentiment.
Useful for Large Traders: Institutions and large traders often use VWAP to ensure they are getting a fair price on large orders, avoiding slippage, and reducing market impact.
Intraday Trend Confirmation: VWAP is particularly valuable in intraday trading, confirming whether the market is in a bullish or bearish trend.
Cons of Using VWAP: Only for Intraday: VWAP resets daily, so it’s primarily useful for day trading and intraday strategies, rather than long-term trend analysis.