- Volume Weighted Average Price (VWAP) is a technical indicator used to analyse the stock market.
- Traders use this indicator to identify the average price a stock has traded throughout the session.
- The average depends on volume and price.
Formula for VWAP:
- VWAP is calculated by taking the summation of (price per transaction in dollars * volume of the stock traded) divided by the total volume of stocks traded in a session.
This is the 1 day chart of Maruti Suzuki India around Jan-Aug, 2020
- VWAP is largely used by institutional traders to ensure the price trades around the average value.
- They buy the shares when the price is below VWAP, so that the price rises back to the average level.
- Similarly, they sell the shares when the price is above VWAP, so that the price falls back to the average level.
- Institutional traders invest in the shares only to revert price back to the average level. They make sure that the price doesn’t cross the average, which might lead to trend reversal.
- Individual traders use VWAP in the opposite sense. They enter the trade and initiate their long positions when the price is above VWAP. Similarly, they initiate their short positions when the price is below VWAP.
- Though VWAP appears to be similar to simple moving average, they are different because in SMA, volume traded is not taken into account.
- The main disadvantage of VWAP is that it is calculated using the historic values and it cannot be used to predict the future price trend.
- Hence traders need to use few other indicators in addition to this indicator to predict the future trend.
- Moreover, the strength of the trend can’t be analysed using VWAP. So, if there is a strong upward trend, price continues to rise upwards and it might be well above VWAP.
- If the traders are waiting for the price to fall below the average level, they have already missed an opportunity to enter the trade. Similarly, it happens during a strong downward trend.