Volume-Weighted Average Price
Introduction
The Volume-Weighted Average Price (VWAP) is a trading indicator that represents the average price a security has traded throughout the day, weighted by volume. It is particularly useful for traders and investors looking to assess the average price at which a security is trading relative to its volume. VWAP is commonly used to measure the efficiency of executions against the benchmark price.
Calculation of VWAP
VWAP is calculated using the following formula:
Formula
Where:
- = Price of the asset at each interval.
- = Volume of the asset at each interval.
- = Total number of intervals.
Example Calculation
Let’s consider an example with the following data for a stock over a trading day:
Time | Price (P) | Volume (V) |
---|---|---|
1 | $10 | 100 |
2 | $10.50 | 200 |
3 | $11 | 150 |
4 | $10.80 | 300 |
5 | $11.20 | 250 |
- Calculate the Total Volume:
- Calculate the Cumulative Price-Volume Product:
- For each time period, calculate :
Time | Price (P) | Volume (V) | Price × Volume (P × V) |
---|---|---|---|
1 | $10.00 | 100 | $1000 |
2 | $10.50 | 200 | $2100 |
3 | $11.00 | 150 | $1650 |
4 | $10.80 | 300 | $3240 |
5 | $11.20 | 250 | $2800 |
- Total :
- Calculate the VWAP:
- Now plug values into the VWAP formula:
Results
- VWAP: $10.79
Python Code
Interpretation of VWAP
Benchmark Price: VWAP acts as a trading benchmark. If the current price is above the VWAP, it indicates that traders are paying more than the average price throughout the day, suggesting strength. Conversely, if the price is below the VWAP, it indicates weaker conditions.
Trend Confirmation:
- Bullish Signal: When the price crosses above the VWAP, it can indicate the beginning of an uptrend.
- Bearish Signal: When the price crosses below the VWAP, it can indicate the beginning of a downtrend.
Volume Profile: VWAP helps in understanding price levels with significant trading volume, which can act as support and resistance levels.
Analogy
Think of VWAP as the average price of a product in a market. If you were shopping and noticed that most shoppers have been buying a product at $10.79 on average throughout the day, this price could be seen as the fair value of that product. If a seller is offering it for more than $10.79, buyers might hesitate, while if it’s available for less, it could create a rush to buy, showing demand. Just as you would use the average price to gauge whether you are getting a good deal in shopping, traders use VWAP to assess market pricing relative to volume.
Conclusion
The Volume-Weighted Average Price (VWAP) is a critical tool for traders to establish a benchmark for average price over a trading period, helping to make informed trading decisions. By utilizing VWAP, traders can understand market trends and potential entry and exit points effectively.
References
- Wilder, J. W. (1978). New Concepts in Technical Trading Systems. Trend Research.
- Investopedia: Volume-Weighted Average Price (VWAP)
- TradingView: VWAP