Volume-Weighted Average Price (VWAP): Definition and Calculation

The volume-weighted average price (VWAP) is a technical analysis indicator used on intraday charts that resets at the start of every new trading session. It's the average price a security has traded at throughout the day, based on both volume and price.

VWAP is important because it provides traders with insight into both the price trend and value of a security.

Key Takeaways

• The volume-weighted average price (VWAP) appears as a single line on intraday charts.
• It looks similar to a moving average line, but is smoother.
• VWAP represents a view of price action throughout a single day's trading session.
• Retail and professional traders may use the VWAP to help them determine intraday price trends.
• VWAP is a trading benchmark that typically is most useful to short-term traders.

How to Calculate VWAP

By adding the VWAP indicator to a streaming chart, the calculation will be made automatically. However, to calculate the VWAP yourself, follow the steps below.

Assume a five-minute chart. The calculation is the same regardless of what intraday time frame is used.

1. Find the average price the stock traded at over the first five-minute period of the day. To do this, add the high, low, and close, then divide by three. Multiply this by the volume for that period. Record the result in a spreadsheet, under column PV (price, volume).
2. Divide PV by the volume for that period. This will produce the VWAP.
3. To maintain the VWAP throughout the day, continue to add the PV value from each period to the prior values. Divide this total by the total volume up to that point.

To make Step 3 easier in a spreadsheet, create columns for cumulative PV and cumulative volume and apply the formula to these figures.

How Is VWAP Used?

VWAP is used in different ways by traders. Traders may use it as a trend confirmation tool and build trading rules around it. For instance, they may consider stocks with prices below VWAP as undervalued and those with prices above it as overvalued. If prices below VWAP move above it, traders may go long on the stock. If prices above VWAP move below it, they may sell their positions or initiate short positions.

Institutional buyers (including mutual funds) use VWAP to help move into or out of stocks with as small of a market impact as possible. Therefore, when they can, institutions will try to buy below the VWAP or sell above it. This way their actions push the price back toward the average, instead of away from it.

Understanding the Volume-Weighted Average Price (VWAP)

VWAP is calculated by totaling the dollars traded for every transaction (price multiplied by the volume) and then dividing by the total shares traded.

Formula

The formula for VWAP is:

$\begin{array}{cc}{\displaystyle }& {\displaystyle \text{VWAP }=\frac{\text{Cumulative Typical Price }\times \text{ Volume}}{\text{Cumulative Volume}}}\\ {\displaystyle }& {\displaystyle \text{where:}}\\ {\displaystyle }& {\displaystyle \text{Typical Price}=\text{High price}+\text{low price}+\text{closing price/3}}\\ {\displaystyle }& {\displaystyle \text{Cumulative}=\text{Total trades since the trading session opened}}\end{array}$