Volume Weighted Average Price is an indicator that takes into account both stock price and trade volume.
For all of the indicator followers, Volume Weighted Average Price is a very important indicator. VWAP (Volume Weighted Average Price) is quite simple to calculate. Traders are using Volume Weighted Average Price to check if the price at which they traded was good or maybe the price was not and they made a wrong trade. Also, intraday traders will use Volume Weighted Average Price as a kind of indicator. As a contrast from the moving average, VWAP provides traders to get price points of interest, to estimate relative strength, and recognize best entries and exits. They will buy when the price is above the VWAP.
What is the Volume Weighted Average price exactly?
Окаy, let’s say you have to compare two obviously good stocks. What you have to do? The answer is logical, you have to check its price trend and the trading volume. Checking the price is reasonable, but why would you check the volume?
Well, the volume is important because it shows how many takers the stock has. Who would like a stock with a few traders? No matter if you think the price is reasonable, you would like to know the volume. Therefore, the VWAP was designed to give traders an insight into the stock price and volume. These are very important info that provides every investor should make a decision whether to buy or not a particular stock.
The formula for calculating VWAP is
VWAP = (Cumulative (Price x Volume)) / (Cumulative Volume)
It will show you the average price that investors have paid for that stock during the trading day. So, you will know how other investors are positioned. Moreover, this measure is used by algos also. They use it to scale into positions. By using it, the algo can break up its position size into segments so as to reduce its impact on the market.
Well, the philosophy of how VWAP is used can lead to various types of trading systems.
It is done by charting software and reveals an overlay on the chart representing the calculations. This design is in the form of a line, similar to the moving average. How to calculate that line?
You have to determine your time frame, for example, 1 minute.
Find the typical price for all periods in the day. You can calculate the typical price when adding the high, low and close prices and that sum you have to divide by 3.
The formula is
H – high
L – low
C – close
TP x V
TP – typical price
V – volume
Now, you will need a cumulative TPV. You will attain this by constantly adding the most current TPV to the earlier values. The exception is the first period from obvious reasons, there was no prior value. This number is becoming larger as the day is coming to an end.
Calculate VWAP based on your data and use this formula:
cumulative TPV/cumulative volume
This will give you a volume-weighted average price for each period. Now, based on this data you can create the line that covers the price data on the chart.
It is better to use a spreadsheet to track the data in case you are doing this manually.
Time to buy according to VWAP
The best time to buy a stock is when the price goes above VWAP. It is a sign that buyers are in control and the majority of intraday positions are in profit. But if the stock price is below VWAP it means that traders have bad trades and losing money on them.
The Volume Weighted Average Price unlike other technical analysis tools, it is best adapted for intraday examination. It offers a good way to identify the underlying trend of an intraday. So, as you can see, when the stock price is above the VWAP, that means the trend is up. Contrary, when the stock price is below the VWAP, that means that the trend is down.
But remember, indicators are using past data to calculate the average. Every indicator starts to calculate at the open and stop to calculate at the close. And as you come closer to the end of the day, the indicator will have more lags. In intraday charts that use very short time frames, you have hundreds of periods in a single day.
Use Volume Weighted Average Price as trend confirmation
We have already said, VWAP provides traders info related to volume and price. But, it will help traders to confirm the appearance of trends that might be rising or going down over the day. For example, you see in the chart VWAP is rising despite the swings in the closing price. You can be sure that there are less sellers than buyers for that stock.
Thus, a rising VWAP indicates a bullish period, while a decreasing VWAP indicates a bearish period.
VWAP is helpful for institutional investors as they need to buy or sell a huge amount of shares but they want to avoid a spike in the volume. They don’t want to attract attention and influence the price.
For example, some institutional investors want to buy 10.000 shares of some companies. If such an investor sets the buy order of 10,000, the consequence will be a spike in the price in the moment of filling the order. So, when other investors recognize that big demand, they would also like to buy the same stock and at a higher price than the bid price of an institutional investor. Of course, traders would sell the stock back at a much higher price. That’s how the stock price rises in a particular case and dramatically increases the “ask” price of the stock. As we mentioned before, some software is able to divide these huge amounts of shares into smaller blocks and execute the trade and not let the closing prices go far from the VWAP. It is important to keep the closing price as much as possible near to the VWAP.
As we explained, VWAP is a lagging indicator. So, don’t try to use it for more than for one-day frame, because it will not show you the right trend. It is good for intraday trading. Also, when the stock or, in some cases, the overall market is bullish, you will not be able to find crossovers for the whole day. So, you will have poor data. By the way, VWAP isn’t able to give you much historical data.
The VWAP provides valuable information, more than the moving averages. Also, it isn’t a tool for a long term investor.