If you are an investor who invests actively in the stock market, you must know the significance of the Volume-Weighted Average Price or VWAP in the share market. VWAP is used as a trading benchmark to measure the stock’s current price and helps the investor create a VWAP trading strategy for intraday transactions.
Read on to understand the concept of VWAP and create a volume-weighted average price strategy for your investments.
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What is the Volume-Weighted Adjusted Price (VWAP)?
The volume-weighted average market price is a commonly used measure in the stock market. As the name suggests, the measure tells you about the average price of a particular stock weighted by the trade volume. VWAP helps you track a particular share’s price over a fixed duration.
The VWAP indicator is calculated daily for a particular stock and plotted on the graph day-wise. The metric is calculated through the stock’s opening price, and the intraday close price is the end point of the calculation.
Several investors use the volume-weighted average price indicator to check for stock price fluctuations in the market. The VWAP sets a benchmark for the investors that help them in comparing the current price levels of the stock to a standard price. Based on this comparison, an investor decides whether to hold the fund or sell it off in the market.
The VWAP additionally helps an investor understand the change in the average stock price during the day.
Several fund managers actively use the volume-weighted average price to understand a particular security’s price performance and path.
Return on equity: Highlights
- The volume-weighted average price is a measure that is a part of the intraday chart and shows the stock’s price movements throughout the intraday trading session.
- Traders use the VWAP and other professionals to determine the price trends of a particular stock.
- The volume-weighted average price is an intraday metric to check for price fluctuations. Hence, it is an important metric for short-term trading.
How to calculate VWAP?
Now that you know the VWAP indicator, you must also know the VWAP formula and how to calculate it. The formula to calculate the VWAP is quite simple. The VWAP of a particular stock is calculated daily and depicted on the stock charts with a single line, showing the stock’s price movements throughout the day.
The VWAP indicator calculation begins with the stock’s opening price and lasts until the stock’s closing price. Hence, it is an intraday measure. The VWAP formula that is used in the calculation is:
Volume weighted average price = (Typical price * Volume) / Cumulative volume
The typical price here refers to the cumulative price of the stock.
To calculate the volume-weighted average price, you must consider a 5-minute stock chart and then find the stock’s average price within those 5 minutes based on the number of times it is traded in the stock market. You need to add the high, low, and close prices and then divide them by 3 to reach an average price. This value is then multiplied by the stock volume for the duration and is called the PV.
Now, divide the PV by the volume of the period to get the volume-weighted average price. Repeat the step by adding the PV values to the last calculated PV value to get a price trend for a particular stock.
VWAP example
Let’s take an example to understand the concept of volume-weighted average price better. The first step involves the calculation of the typical price of the stock. Here, you must consider the stock’s high, low, and closing prices. For instance, if H=25, L=15, and C=20, the typical price of the stock will be:
Typical price = (25 + 15 + 20)/3 = 20
Now, consider the volume of the stocks. Here, V=20.
Hence, the cumulative volume * price = 400.
The volume keeps fluctuating throughout the day. Hence, if you are using an Excel sheet to calculate the volume-weighted average price, you must have a separate column for volume. Assuming that the cumulative volume for the day is 40, the VWAP is = 400/40 = 10.
The VWAP is calculated for all price points throughout the day and is represented using a thin line on the stock chart. While you can calculate the VWAP to keep a tab on the stock prices, the trading platform you use for intra-day trading automatically generates the VWAP line on the stock chart.
Importance of VWAP formula
The VWAP is a crucial metric for stock market traders and investors planning to buy a stock. The measure is based on the historical data of the stocks, and hence it is an important metric for intraday trading. The measure has the following importance:
- It gives you an idea of the market performance. The market is declared bearish if the stock price is below the VWAP. The market is likely bullish if the stock price exceeds the VWAP.
- The VWAP will help you in making stock buying and selling decisions. The tool is actively used in the technical analysis of stocks. Therefore, you can use the VWAP to make trading decisions, decide on entry and exit points, and more.
- VWAP is a better metric than the moving average, as it considers the stock’s last and current price throughout the day to generate the line.
Conclusion
The VWAP is a measure that gives you an insight into stock price movements throughout the day. The measure considers the high, low, and close prices for its calculations. Hence, you can easily use it to make intraday trading decisions. You cannot use the metric to make future investments as it does not consider the long-term perspective. Consult a trade expert before employing VWAP.
