What Is the Volume Weighted Average Price (VWAP) Indicator?

The Volume Weighted Average Price (VWAP) indicator provides a security’s average price over a specific period. It integrates both price and trading volume, offering an understanding of where a security has traded throughout the day. VWAP is primarily utilized as an intraday benchmark by large institutional traders to assess the quality of their trade executions.

Core Concepts of VWAP

VWAP is “volume-weighted” because it assigns greater importance to price levels where higher trading volumes occurred. This weighting mechanism ensures that the average price reflects periods of significant market activity. Price movements accompanied by substantial volume carry more influence on the VWAP calculation than those with lower volume.

To calculate VWAP, two primary data points are used: price and volume. The price component involves the “typical price” for each interval, derived by averaging the high, low, and closing prices. This input is chosen because it represents a balanced view of the price range within an interval. Volume, representing the number of shares traded, provides the context of market participation at each price level.

The integration of these two inputs makes VWAP distinct from a simple moving average, which only considers price. By factoring in volume, VWAP provides a more accurate representation of the actual average price at which most trading activity took place. This combination helps traders understand the consensus value of a stock during the trading day.

VWAP Calculation Method

The Volume Weighted Average Price is calculated as the sum of (Typical Price × Volume) divided by the sum of Volume, over a defined period, typically intraday. This calculation begins at market open and resets at the close of each trading session.

To calculate VWAP:
Determine the Typical Price for each interval (e.g., 5-minute or 15-minute periods) by averaging the high, low, and closing prices.
Multiply this Typical Price by the volume traded during that interval to get a “Price-Volume” product.
Sum all individual “Price-Volume” products for the trading period.
Sum all volumes traded during the same period to get the total volume.
Divide the total “Price-Volume” sum by the total volume sum to arrive at the VWAP.

For illustration, consider a stock trading over two 5-minute intervals. In the first interval, high $10.20, low $9.80, close $10.00, with 100 shares volume. The typical price is ($10.20 + $9.80 + $10.00) / 3 = $10.00. The price-volume product is $10.00 × 100 = $1,000.

For the second interval, high $10.50, low $10.10, close $10.40, with 150 shares volume. The typical price is ($10.50 + $10.10 + $10.40) / 3 = $10.33. The price-volume product is $10.33 × 150 = $1,549.50.

To find the VWAP for these two intervals, sum the price-volume products ($1,000 + $1,549.50 = $2,549.50) and sum the volumes (100 + 150 = 250). Dividing the total price-volume sum by the total volume ($2,549.50 / 250) yields a VWAP of approximately $10.20. While manual calculation is possible, trading platforms automatically compute and display VWAP on charts.

Interpreting VWAP

The primary function of VWAP is to provide a benchmark for a security’s average price throughout the trading day. It offers a smoothed-out indication of the security’s price, adjusted by the volume traded at each price level. This makes it a valuable reference point for evaluating whether a current price is relatively high or low compared to the day’s trading activity.

The relationship between a security’s price and its VWAP offers actionable insights. When the price is trading above the VWAP line, it suggests that buyers are willing to pay more than the average volume-weighted price, indicating buying pressure or a bullish market sentiment. Conversely, if the price is trading below the VWAP, it signals selling pressure, meaning sellers are willing to accept less than the average volume-weighted price.

Institutional traders frequently use VWAP as a benchmark for executing large orders. Their aim is often to achieve an average execution price that is better than or close to the prevailing VWAP, minimizing market impact. For instance, they might strive to buy shares below the VWAP or sell above it, signifying a favorable trade execution relative to the market’s average price.

It is important to understand that VWAP is a lagging indicator, meaning it reflects past price and volume data rather than predicting future movements. The calculation uses historical information, and as the trading day progresses, the indicator’s lag can increase. Despite this, VWAP remains a widely used tool for assessing market sentiment, identifying potential support and resistance levels, and evaluating the quality of trade executions.