Introduction to Volume Weighted Average Price (VWAP)
Volume Weighted Average Price (VWAP) provides an insight for the daily trader to understand the average price that the security had traded during the day by taking both volume and the price into account. It is an important trading benchmark that is plotted day wise, starting from the opening price and ending at the close price intraday.
Understanding Volume Weighted Average Price (VWAP)
Volume Weighted Average price is the total average price with respect to the volume of the security and it is calculated using the following formula: VWAP = (Cumulative (Price * Volume)) / (Cumulative Volume) This average price with respect to volume compares the current price to a benchmark which helps investors decide when to enter and exit the market during the day. Hedge fund and Mutual Fund managers use this price to manage portfolios, purchase a volume of shares with respect to the price without causing large impact on the market. They buy below the average and sell above it to make maximum possible profit, while also retaining the amount towards the average. Retail traders use the VWAP to review the performance of the security as its summary and assuming possible trends and patterns the security may form. As such, they can make trading decisions, to assume short positions when the price is under VWAP or retain the security for long when the price is above the average.
Highlights of Volume Weighted Average Price (VWAP)
On a price chart, VWAP may look similar to Simple Moving Average. However similar they look, both of them are calculating different things. VWAP is calculated over a day, whereas SMA is calculated for a period of time and only considers the closing prices and not the volume. VWAP offers a very one-dimensional perspective to firmly decide on whether a short or a long position is preferred in trading. It is only a summarized insight into the day’s performance of the security and thus falls as an inadequate measure. Because it is a summarized version of only one day, VWAP shows no real effect in making predictions or calculations for the future except for assumptions. VWAP can be calculated for a period of time. However its accuracy may not always be reliable.
