Apply for the Vishal Mega Mart IPO through UPI in just minutes.
Open a Free Demat Account
Pay ZERO maintenance charges for the first year, get free stock picks daily, and more.
Trade Now, Pay Later with up to 4x
Never miss a good trading opportunity due to low funds with our MTF feature.
Track Market Movers Instantly
Stay updated with real-time data. Get insights at your fingertips.
VWAP (Volume Weighted Average Price)
By Bajaj Broking Team
August 28, 2023
4 mins read
Share Market
ENGLISH
Listen to our Podcast: Grow your wealth and keep it secure.
0:00 /
0:00
Technical analysis of a stock or an asset can give you deep and valuable insights into the potential price movements. These insights can help increase your trading success rate. One of the many technical indicators you can use to make well-informed trading decisions is the Volume Weighted Average Price.
It is a simple indicator that lets you know the average price at which an asset was trading over a specific period. It is widely used in intraday and short-term trading. Here’s everything you need to know about this particular technical indicator.
What is the VWAP (Volume Weighted Average Price)?
The Volume Weighted Average Price, also known as VWAP, is a dynamic technical indicator that shows the average trading price of an asset relative to its volume for a specific period. Since the indicator is dynamic, it keeps changing as the trading session progresses and the units of the asset are bought and sold.
Generally, VWAP is calculated on an intraday basis and is reset at the end of a trading day. The indicator is widely used by large institutional investors including mutual fund houses when buying or selling an asset on the stock exchange.
To calculate the VWAP of an asset, all you need to do is use the following Volume Weighted Average Price formula.
VWAP = (Total Price * Total Volume) ÷ Total Volume
Here, the total price represents the sum of the prices of all the executed trades, whereas the total volume represents the sum of the volume of all the executed trades.
As a trader, manually calculating the VWAP for an asset can be extremely challenging, if not impossible. Fortunately, you don’t have to perform any manual calculations to get to know the Volume Weighted Average Price. You can find it on a stockbroker’s trading platform, a stock exchange website and even on certain financial news websites.
The Significance of Volume Weighted Average Price (VWAP)
Analysing just the average price of an asset is unlikely to provide any insight into an asset’s price action. However, reading into the price action along with the trading volume can give you a true context of how the asset has moved during a specific period.
Despite being a simple technical indicator, the VWAP is routinely used by institutional investors including mutual fund houses to plan large block trades. Institutional investors are known to make large trades. However, buying or selling significantly large quantities of an asset can lead to heavy swings in the price and a spike in volatility.
Such large orders may also cause panic in the markets. To avoid such an undesirable situation, institutional investors break up large trades into multiple smaller ones and attempt to execute them at the current Volume Weighted Average Price of an asset. This reduces the risk of a spike in volatility and wild price swings.
The Volume Weighted Average Price of an asset can help plan your trades. Here’s how it can be interpreted and used.
If the current price of an asset is above its VWAP, it indicates a bullish sentiment or continuation of a bullish trend and can be interpreted as a buying opportunity. On the other hand, if the current price of an asset is below its VWAP, it might indicate a bearish sentiment or a continuation of a bearish trend. In such a situation, you can consider selling or shorting the asset.
And finally, if the current price of the asset crosses its VWAP line, it may be interpreted as a potential trend reversal depending on whether the price crosses the VWAP from above or below.
Difference Between VWAP and SMA (Simple Moving Average)
Criteria
VWAP (Volume Weighted Average Price)
SMA (Simple Moving Average)
Calculation
Considers both price and volume, giving weight to high-volume trades
Averages prices over a set time period without considering volume
Use Case
Used for intraday trading to gauge market trends
Often used in longer-term trend analysis
Interpretation
Indicates potential buying/selling points relative to market volume
Shows general price direction over time
Suitability
More accurate for short-term decisions
Ideal for understanding long-term trends
Reset Frequency
Resets daily with each trading session
Continuous without daily reset
How to Trade with VWAP Indicators
Identify Trends: When a security's price is above the VWAP indicator, it may indicate a bullish trend, signaling a potential buy. Conversely, prices below VWAP suggest a bearish trend.
Set Entry and Exit Points: Traders often buy when the price is below the VWAP and sell when it's above, using VWAP to optimize entry and exit points.
Combine with Other Indicators: VWAP works best alongside other indicators like the SMA (Simple Moving Average) for a comprehensive analysis.
Avoid Overuse: VWAP is ideal for intraday trading but not suitable for long-term trend predictions due to daily resets.
Limitations of the Volume Weighted Average Price
As with any other technical indicator, the Volume Weighted Average Price also has certain limitations. As a trader, you need to be aware of what they are before you use them as part of your trading process.
Firstly, VWAP is generally calculated only for a short period and therefore doesn’t give you a complete history of an asset’s price action. Also, since the indicator relies heavily on volume, it may not work well or produce accurate signals if the trading volume is low. And finally, the VWAP doesn’t account for important market-moving events which can lead to a temporary spike in the volatility and trading volume.
Conclusion
Despite its limitations, the Volume Weighted Average Price continues to be used widely by both retail and institutional traders. However, if you’re planning to trade using this technical indicator, remember to account for false trading signals. Moreover, it is advisable to use other technical indicators in conjunction with the VWAP to get a more accurate context of an asset’s price action before placing a trade.
What is Volume Weighted Average Price (VWAP) in trading?
Answer Field
VWAP, or Volume Weighted Average Price, is a technical indicator used in trading to determine the average price of a security adjusted by its trading volume. This metric helps traders understand if a security is trading above or below its average volume-adjusted price.
How is VWAP calculated in the stock market?
Answer Field
VWAP is calculated by multiplying each trade price by its volume and dividing by the total volume traded during a period. This calculation allows the VWAP indicator to reflect both price and volume, making it ideal for intraday trading strategies.
What is the difference between VWAP and simple moving average (SMA)?
Answer Field
Unlike the simple moving average (SMA), which considers only price, the VWAP indicator factors in volume, giving more weight to trades with larger volumes. This makes VWAP more reflective of true trading activity compared to the SMA.
How do traders use VWAP to make buy and sell decisions?
Answer Field
Traders use VWAP to gauge market trends: a price above VWAP suggests a bullish trend, while a price below indicates a bearish trend. This helps traders decide whether to take long or short positions based on VWAP levels.
Is VWAP more suitable for intraday or long-term trading?
Answer Field
VWAP is primarily used for intraday trading since it resets daily, providing accurate price and volume insights for short-term trades. For long-term trends, other indicators like the SMA might be more suitable.
What are the advantages of using VWAP over other indicators?
Answer Field
VWAP offers a precise average by incorporating trade volume, unlike other indicators focused solely on price. This makes VWAP a preferred choice for institutional traders regularly executing large orders without significantly impacting market prices.
How does volume impact the accuracy of the VWAP indicator?
Answer Field
The VWAP indicator’s accuracy increases with higher trading volumes, as it weights price levels according to volume. This volume adjustment minimizes the effect of small, low-volume trades on the calculated average price.
Can VWAP be used in conjunction with other technical indicators?
Answer Field
Yes, VWAP is often combined with indicators like the SMA to enhance trading strategies. While VWAP shows volume-adjusted trends, SMA helps in identifying longer-term trends, making them complementary tools in technical analysis.