Volume Weighted Average Price, or VWAP, is an important indicator often used by day traders and institutional investors alike. Understanding the VWAP meaning and the VWAP calculation can help drive better buy and sell decisions.
What Is The Volume Weighted Average Price (VWAP)?
The volume-weighted average price, or VWAP, is the average price of a stock over a period of time, adjusted for the volume of those trades.
Because of the volume component, VWAP assigns more weight to larger trades. And because it’s an average price across the period of time, VWAP offers a smoother view of the trading trend during the day.
Volume-Weighted Average Price Formula
In theory, a perfect VWAP formula would include every single trade made during the trading session. With that data, the VWAP formula would look like this:
But that trade-by-trade data is not generally available. So, as a shortcut, traders can use what is known as the “typical price”
The typical price is equal to the average of the high, low, and close price for an intraday period. In other words, the typical price formula is:
For each period (traders usually use 1-minute or 5-minute increments), the typical price is multiplied by the volume within that period. That figure is then divided by total volume for the day to that point, creating this VWAP formula:
How To Calculate Volume-Weighted Average Price
An example here may be instructive. Let’s look at hypothetical trading for ABC stock during the first 17 one-minute increments of a trading session:
For each increment, we first need to calculate the typical price. Again, that formula is (high + low + close) / 3.
So for the 9:30 am increment, our typical price equals ($150.39 + $150.22 + $150.31) / 3, or $150.3067. For 9:31 am, our calculation is ($150.47 + $150.38 + $150.41) / 3, or $150.42.
We repeat that calculation for each increment; we now have 17 typical prices. We then multiply each individual typical price by the volume for that time period.
For 9:30 AM, for instance, we multiply our typical price of $150.3067 by the volume of 380. At 9:31 AM, the typical price of $150.42 is multiplied by 5,270. These 17 sums are then totaled and divided by total volume for the entire period to get our VWAP from 9:30 am to 9:46 am.
In this case, the 17 sums (sometimes known as Typical Price Volumes, as they are derived by multiplying typical price and volume) total $4,628,406.32. Total volume over the entire 17-minute period is 30,604, providing a 17-minute VWAP of $151.24.
Calculating VWAP In Excel
It’s obviously untenable to do these calculations on a line-by-line basis. The time taken would offset any potential trading benefits from calculating VWAP in the first place.
A well-designed Microsoft Excel spreadsheet can automate this process. Start by importing the necessary data — date, time, high, low, close, and volume. The next step is to create a column, which for simplicity’s sake can be abbreviated as ‘TPV’ for Typical Price Volume
We’ll then create a simple Excel formula for Typical Price Volume in cell G2, which mimics the TPV formula:
Again, we are looking to sum High, Low, and Close, which is (C2+D2+E2), and then divide by 3 to get the average. That typical price is then multiplied by volume for the increment (F2).
Fill or paste that formula down, and we have typical price for our time increments:
Now, we want to move to VWAP. To calculate VWAP, we can use an absolute reference in Excel. An absolute reference is signified by dollar signs preceding the letter and number of the cell, and anchors that cell when using a fill or paste function.
To calculate our VWAP, we want to sum our TPVs to that time point, and divide that total by volume to that time point. Our Excel formula thus looks like this for cell H2:
And so we see that our sheet now calculates VWAP for each increment:
VWAP Strategy — How To Use VWAP
The core thought behind VWAP is that the incorporation of volume creates a truer sense of demand for and the trend of a stock. Imagine a simplistic hypothetical in which a stock ticks up on two trades, each for 10,000 shares — and then ticks down on two 100-share orders. The stock is back where it started — but demand in these four trades overall seems far more bullish than bearish.
Institutions that need to move those high-volume trades will thus often look to get as close to VWAP as possible. Staying near VWAP allows heavy volume to move in a series of trades without substantially moving the stock, since those trades in theory should be roughly in line with where demand sits.
Traders of all sizes, meanwhile, look at VWAP as better signifying where demand sits than a simple candlestick chart. A rising VWAP trend line shows that more money is moving into the stock. Yet if the stock price doesn’t reflect that strength, there may be a day-trading opportunity.
The converse is true as well: a falling VWAP trend line suggests that sellers are looking to move more volume, but that overall bearishness may not be reflected in the absolute trade-by-trade prices of the stock.
Traders who use VWAP strategies believe that the trend line toward the start of the day can often signal the direction of the stock for that session. If VWAP is rising, but the stock price isn’t, in many cases the market will eventually play catch-up — meaning day traders can buy the stock ahead of time.
More experienced traders will also use more complex VWAP strategies, viewing the metric as support or resistance much as longer-term traders do with moving averages.
VMA vs VWAP
That said, VWAP is not the same as moving averages, including what is known as VMA (a Variable Moving Average).
The core distinction is simple. VWAP is an intraday measure; its usefulness lasts no longer than a session. It’s an average price used as a benchmark for trading that day.
Moving averages, whether VMA or otherwise, consist of prices across multiple sessions.
Why Is The Volume-Weighted Average Price Important?
Again, VWAP is used by experienced day traders as a metric that provides added context to simple price movements. But the metric has an important role in the corporate world as well.
Many corporate transactions include “earnouts”, consideration that is based on a future stock price. Among the most common such transactions are SPAC (special purpose acquisition company) mergers.
SPACs bring private companies to the public market via mergers, most often at a price of $10 per share. Often, the owners and/or management teams of those private companies can receive additional shares if the stock price of the public firm reaches certain targets within a given time period. In this way, they are rewarded if the business outperforms expectations after the merger is complete.
In addition, nearly all SPAC deals include warrants. Like earnout shares, those warrants become redeemable for common stock once certain price targets are reached.
In theory, however, these price targets could be gamed. If an executive needed the stock to reach $15, for instance, they could make a single trade at that price.
To prevent any potential chicanery — or simply an odd trade that triggers earnouts or warrant redemptions — merger agreements require that the price target be based on VWAP across an entire session, rather than any single trade. In many cases, the target VWAP must be reached in 20 of 30 days.
This setup offers two advantages. First, it ensures that the stock holds the target level for a reasonable amount of time. Second, by using a volume-based measure like VWAP, it ensures that the market as a whole, and not just a few traders, is willing to pay that price.
Who Created VWAP?
According to one source, VWAP was first used in 1984 by a trader at Abel Noser, a Wall Street trading firm. It’s since become a core part of many trading strategies.