The Volume Weighted Average Price (VWAP) is, as the name suggests, is the average price of a stock weighted by the total trading volume. The VWAP is used to calculate the average price of a stock over a period of time.
The volume weighted average price helps compare the current price of the stock to a benchmark, making it easier for investors to decide when to enter and exit the market. Also, the VWAP can assist investors in determining their approach towards a stock (active or passive) and make the right trade at the right time.
How to Calculate Volume Weighted Average Price
The volume weighted average price is calculated for each day. It starts when the markets open and ends when the markets close for the day. Since it is done every day, the calculation uses intraday data. The formula for calculating VWAP is as follows:
The first step is to calculate the typical price for the stock. It is the average of the high price, the low price, and the closing price of the stock for that day. Using the formula [(H+L+C)/3], if H = 20, L = 15 and C = 18, the stock’s average price would be:
Typical Price = (20+15+18) / 3 = 17.67
Next, you need to multiply the typical price by the volume. If V = 20, then:
17.67 * 20 = 353.33
You can keep a running total of the volume as they aggregate through the day to give you the cumulative volume. The cumulative volume, in our example, is 78.
Therefore, using the VWAP formula above:
VWAP = 353.33 / 78 = 4.53
The volume weighted average price can be calculated for every period to show the VWAP for every data point in the stock chart. The results of the VWAP are represented on the stock chart as a line. An investor does not always need to calculate the VWAP; it is done automatically on the trading software. The trader only needs to specify the desired number of periods to be considered in the VWAP calculation.
Importance of Volume Weighted Average Price
The volume weighted adjusted price is the true average price of the stock and does not affect its closing price. The VWAP calculation, like the moving average, experiences a lag as it is based on historical data, making it better suited for intraday trading. VWAP is a popular tool among investors for many reasons:
1. It can indicate if the market is bearish or bullish
The market is bearish when the price is below the VWAP and bullish if the price is above the VWAP. During a bullish market, there will be an increase in the buying price, and the trend line on the chart will move upward. However, during a bearish market, there is more pressure to sell the stock, leading to a downward trend on the stock chart.
2. You will know when to sell or buy
Investors who use the VWAP as a technical analysis tool will not buy a stock when there is a signal to do so. Instead, they wait for a favorable price. A trader who pays for a stock trading below the VWAP line will not pay more than the stock’s average price.
However, traders who use the VWAP line as an indicator will be able to buy at a low price, thus making more profits when they sell the stock. VWAP helps the investor make more informed decisions when buying stocks.
3. It is a better tool than the moving average
The VWAP is also used by pension plans looking to occupy a larger portion of the market. It allows them to take a different position without disrupting the market too much. With day trading, timing is the most crucial element, and the VWAP lets investors know the right time to enter or exit the market and not just follow the general trend.
The VWAP is a great indicator when choosing what stocks to buy, but it provides greater value when used with other trading strategies. It is a formula that can tell you a lot about the current and future state of a stock for both long and short positions. VWAP can help investors make more educated trades.
Thank you for reading CFI’s guide on Volume Weighted Adjusted Price (VWAP). To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: