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- Volume Weighted Average Price
Volume Weighted Average Price
What is Volume Weighted Average Price (VWAP)?
The Volume Weighted Average Price (VWAP) is a trading benchmark used by traders that gives the average price an instrument has traded at throughout the day, based on both volume and price. It provides traders with insight into both the trend and value of the instrument. VWAP is calculated by summing up the total dollars traded for every transaction (price multiplied by the number of shares traded) and then dividing by the total shares traded.How VWAP is Calculated
The formula for VWAP is:- VWAP = (Cumulative (Price * Volume)) / Cumulative Volume
Applications of VWAP
VWAP is used by traders and institutions in various ways:- Institutional traders use VWAP to ensure they are executing large orders at the best possible average price without significantly impacting the market.
- Retail traders use VWAP as a trend confirmation tool, where prices above VWAP indicate a bullish trend and prices below VWAP indicate a bearish trend.
- VWAP is also used to identify support and resistance levels dynamically.
VWAP vs. Moving Averages
While both VWAP and moving averages provide average price information, VWAP incorporates volume, making it more reflective of the actual market activity. Moving averages, on the other hand, simply average the price over a set period without considering the volume.VWAP in Trading Strategies
Traders often use VWAP in their strategies:- **Mean Reversion**: Traders might buy when the price is below VWAP and sell when it is above, betting on the price reverting to the mean.
- **Trend Following**: Traders might use VWAP to confirm trends, buying when the price is above VWAP and selling when it is below.
- **Support and Resistance**: VWAP acts as a dynamic support and resistance level, helping traders to make decisions on entry and exit points.
Advanced VWAP Variants
There are several advanced variants of VWAP:- **Anchored VWAP (AVWAP)**: Unlike the traditional VWAP that starts at the beginning of the day, AVWAP can be anchored to any point in time, providing flexibility in analysis.
- **Moving VWAP (MVWAP)**: This version works like a moving average but with volume weighting, useful for longer-term analysis.
- **VWAP Bands**: Similar to Bollinger Bands, VWAP bands use standard deviations to create upper and lower bands around the VWAP, indicating potential reversal points.
Limitations of VWAP
Despite its usefulness, VWAP has some limitations:- **Intraday Only**: VWAP is typically reset at the start of each trading day, making it less useful for longer-term analysis.
- **Volume Dependency**: In markets with low volume, VWAP might not be as reliable.
- **Lagging Indicator**: Like all moving averages, VWAP is a lagging indicator and might not react quickly to sudden market changes.
VWAP in Automated Trading
VWAP is widely used in automated trading systems:- **Execution Algorithms**: Many execution algorithms use VWAP to minimize market impact and achieve better execution prices.
- **Trading Robots**: Robots can be programmed to trade based on VWAP signals, automating the process of buying and selling based on predefined criteria.