The volume weighted average price (VWAP) is a technical indicator representing the average price of a security traded relative to the traded volume. Therefore, VWAP means to have a combined indicator of the standard volume in shares indicator and the price. That's it.

The volume weighted average price is more than just modifying a classic moving average. The moving average indicator doesn't take into consideration volume. Volume is important as it might happen that security was traded at a given price. Some traders only use price and volume in combination without any other indicator. Volume weighted average price prevents giving equal weightage to all the price points. A volume-weighted average moves the average price towards the price points that had enough volume.

VWAP indicator provides traders with insight into both the trend and value of a security. It is used both as an entry and exit point to trade securities. It can also be used to find out whether the current price can be considered fair.

## How Do I Setup My VWAP

The VWAP is calculated during the regular session and not available in premarket trading. However, some trading platforms can be set up to start VWAP calculation at the beginning of the pre-market.

Investors often use it as a benchmark for trading. Some pension and mutual funds also fall into this category.

The purpose of using the VWAP trading target is to ensure that the trader fulfilling the order does so based on market volume. It also helps in assessing price changes.

Weighted Average Volume Price is easy to calculate and has broad applicability in trading. Another advantage of using VWAP is that you can display it at any chart time frame.

VWAP is often used in algorithmic trading. Algorithms that use VWAP as a target belong to a category of algorithms called volume sharing algorithms.

## Calculating VWAP

The formula for calculating VWAP is: VWAP = (Cumulative (Price * Volume)) / (Cumulative Volume)

Trading software and charts overlay the VWAP indicator on the pricing pane. The visualization takes the form of a line, which is similar to other moving averages. The line is calculated as follows.

• Choose a time frame based on your expected trading frequency (1 minute, 5 minutes, etc.)
• Calculate the typical price for a given period. The typical price is the average of high, low and closing price: (H+L+C)/3
• Multiply the typical price for a given period by the volume for that period. It will generate for us a value called TPV.
• Keep a cumulative running value of the TPV values, called cumulative-TPV. This is done by continually adding the most recent TPV to the initial values (the first period has no prior value).
• Keep a running total of cumulative volume. Do this by adding the most recent volume to the already calculated cumulative volume.
• Calculate VWAP: [cumulative TPV รท cumulative volume].

## How is VWAP used in trading?

VWAP can be used along the lines of moving average or stand-alone. The prices above the VWAP reflect bullish sentiment, while prices below the VWAP reflect a bearish sentiment. Investors can go short when the stock price has dropped below VWAP or go long when the stock price rises above the VWAP.

The VWAP represents the true mean price of the stock during the day. It also doesn't affect the closing prices. Given that VWAP calculation is based on historical data repeatedly beginning with the first finished period in the chosen time frames, it is better suited for day trading. If you enable pre- and after-market hour data, the VWAP will not care about it since the VWAP is only plotted during regular trading hours.

Even though one could use VWAP for position trading, there are certain conceptual challenges. One of the biggest challenges pre-market and after-market price spikes. The prices are often volatile overnight, and the volume is low, which will lead VWAP to fluctuate significantly from one day to another. The opening gap to the up-or downside can easily vary by a double-digit percentage, especially during earnings.

Another challenge is related to news. A market or firm related information release gives a new insight into a stock. This information is generally released after trading halts at the end of the regular trading hours or before starting the regular trading hours on a new day. VWAP gives a significant weightage to old prices, to be more specific, to the previous day and starts calculation again with the new day. Hence, price information related to news won't be given enough weightage in the calculated VWAP.

### VWAP Strategy

Look at the chart below from Macy's (M). The VWAP changed significantly between the close of the previous day's regular trading hours to the opening candle of the new day. The VWAP was not plotted during extended market hours. Macy's lost about 5% overnight, but the movement on the following day was bullish all day long with prices above VWAP.

The volume-weighted average price can also act as a moving average line. A declining VWAP line shows a downward trend in prices, while an upward trending line signals an upward price trend.

Traders often use it as a resistance line. VWAP resets every morning before 9:30 am EST and is calculated every minute until the market closes at 4 pm EST.

Institutional algorithms, as well as buyers, also use VWAP to plan market entry.

The VWAP acts as support and resistance. It assists in selling or shorting when prices are extended to the upside or bounce from below the VWAP to the VWAP. Vice versa, the underlying asset is bought if prices are significantly below VWAP or if prices are above VWAP and touch it from the upside as support level.

Some traders also trade the VWAP-cross via automated strategies. For instance, let's assume if a stock is trading at \$40 and the VWAP is \$40.05. If VWAP cross above \$40.05 and the stock price goes higher to \$40.1, you can look to get long on this opportunity. The stock is showing signs of strength and momentum to the upside.

As you can see, there is no fixed concept. Like any other support- and resistance level from other indicators and lines, the VWAP also requires practice and a well-analyzed method that works best in your specific asset and time-frame.

## What is Anchored VWAP?

The Anchored VWAP is a modified version of VWAP. It ties calculations to a specific price bar decided by the trader. It is similar to the traditional VWAP, as it incorporates price and trading volume in a weighted average. Like VWAP, it can also identify the areas of support and resistance on the chart.

VWAP calculations start with the first bar of the day and end with the day's final bar. Under certain situations, a trader would prefer to look at the VWAP line based on a less arbitrary starting point. It might also prove useful to extend the VWAP line beyond the end of the trading day.

Anchored VWAP lets one decide the price bar where calculations begin. This makes it easy to see whether the bulls or bears have dominated since a particular point in time.

Chartists generally choose the starting price bar as one that marks a shift in market trend. Earnings, news, or other announcements are good choices for such starting points. Once the starting point is decided, the Anchored VWAP line is charted using price and volume data from that point onward.

In other words, the anchored VWAP allows traders to apply the calculation method to any starting point. You can choose a previous high, previous low, opening gap, specific time as an anchor. While more flexibility might sound good, it also has a significant downside since too many options may lead to the point that you never find the right method with too many variables. It is like being in the supermarket facing hundreds of wines. You try this one or try this one, but you may never find the great one. If there would only one wine, and you would test that one, you could say fast if it was good or not.

## Wrap Up

VWAP is a modified version of the moving average known from technical analysis. VWAP is a combination of both price and volume and provides more relevant information than the moving averages. It is widely used in trading strategies to take market entry and exit decisions. The volume weighted average price is most beneficial in day trading.

There are many trade setups based on the volume weighted average price from long positions to short positions, from short term trading to swing trading. The trading indicator is popular among the trading community and included in all major charting- and trading platforms. Price action and volume are the two components, and the calculation is simple. A minute chart can be used throughout the day or a higher time frame. Day traders often develop a trading strategy to analyze the intraday price movement relative to the VWAP support and resistance. If prices go through VWAP, traders usually wait to confirm the broken trend and wait for another touch from the other side.

Updated: November 23, 2020
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