Volume Weighted Average Price (VWAP)

VWAP (Volume Weighted Average Price) is a dynamic, weighted average designed to more accurately reflect a security’s true average price over a given period. VWAP is the summation of money (Volume x Price) transacted divided by the total volume over any time horizon, typically from market open to market close.

VWAP is more often used on daily charts, but it can also be plotted on weekly, monthly and quarterly timeframes, which makes it applicable for swing, position traders and Options strategies.

VWAP places more emphasis on higher volume candles, and ‘speeds up’ during high volume and ‘slows down’ on low volume.

Algo Executions

Institutional traders uses very fast and sophisticated VWAP levels every day and is a dynamic benchmark universally understood and applied by institutions, and is the most common benchmark used to determine transaction costs and traders’ performance.

VWAP is often used in algorithmic trading. When using VWAP as a target it is known as “Volume Participation Algorithms”.

  • “Guaranteed VWAP Execution” – When a broker pledges an order at the VWAP.
  • “VWAP Target Execution” – When a broker trades around VWAP in a best effort and answer to the client the realized price.

VWAP Calculation

When comparing a SMA (simple moving average) with VWAP the results can be significantly different.

SMA only takes Price in consideration:

  1. $1, 050.00 = ($150.00 + $160.00 ….)
  2. 175.00 = $1, 050.00 / 6

VWAP on the other hand considers Volume and Price:

  1. $750.00 = ($150.00 * 5)
  2. $1,600.00 = ($160.00 * 10)
  3. $101,050.00 = ($750.00 + $1,600.00 …)
  4. 536 = (5 + 10 + 10 …)
  5. $189.00 = ($101,050.00 / 536)

VWAP Strategy

VWAP is used in many different ways, both by short-term traders and institutions. VWAP behaves differently based on the period of trading days, because of its cumulative nature, and it is very sensitive for price changes at the beginning of day, but insensitive at the end of trading day.

  • When the price goes above VWAP value, the trend seems to be up. Institutions recognize it as good moment to short, but short-term traders will look to go long.   
  • When the price goes below VWAP value, the trend seems to be down. Institutions recognize it as good moment to go long, but short-term traders will look to short.   

Return to the Mean

Throughout the trading day price is likely to return the the mean several times, since VWAP acts as a magnet establishing what is defined as “‘Fair Value”.

Standard Deviation

When applying Standard Deviation to VWAP, statistically the 3rd sigma (upper/lower) band provides a 99.7% probability of a price reversal. The probability of reversal on the 2nd sigma is 95.4%, and the 1st sigma is about 68.2% of price reversal.

Support and Resistance

The upper bands of VWAP between the 2 sigma and 3 sigma acts as resistance, causing price to reverse to the down side. The lower bands of VWAP acts as support, while VWAP line can be either support/resistance causing price reversal.

Source of reference:

The references below are not investment recommendations, but rather sources for you to check (ie. get to know what is out there)


Note:  
This blog post is based on the “Scaling Volatility Efficiently” presentation made on August 9, 2017 by Gonzalo Peres