loader2
Partner With Us NRI

VWAP: Unveiling the Power of Volume Weighted Average Price for Traders

In the realm of technical analysis, traders are constantly on the lookout for indicators that provide valuable insights into market trends and price levels. One such indicator that has gained popularity among traders, particularly in the realm of algorithmic trading, is the Volume Weighted Average Price (VWAP). VWAP is a powerful tool that incorporates both price and volume data to provide a comprehensive view of market dynamics. In this blog post, we will explore the concept of VWAP, its calculation method, and its practical applications for traders.

Understanding Volume Weighted Average Price (VWAP)

Volume Weighted Average Price (VWAP) is a technical indicator used to determine the average price at which a security has traded throughout the day, factoring in the volume of each trade. Unlike traditional average price calculations, VWAP places more weight on periods of higher trading volume. By doing so, VWAP provides traders with a more accurate representation of the average price and is particularly useful for intraday trading.

How VWAP indicator can be used to analyze stocks?

Let's use a real-life example of an Indian stock to explain changes in position using the Volume-Weighted Average Price (VWAP) indicator. For this example, we'll consider the stock of Tata Consultancy Services (TCS) historical price and volume data. Please note that the stock prices, volume data, high and low prices mentioned in this example are purely fictional and not based on actual market data.

Here's the table showing the historical prices, assumed high and low prices, and volumes of TCS over a trading day:

 

Now, let's calculate the VWAP for each trading day using the formula mentioned:

Calculation

There are five steps in calculating VWAP:

1. Calculate the Typical Price for the period.

[(High + Low + Close)/3)]

2. Multiply the Typical Price by the period Volume.

(Typical Price x Volume)= VWTP

3. Create a Cumulative Total of Typical Price.

Cumulative(Typical Price x Volume)

4. Create a Cumulative Total of Volume.

Cumulative(Volume)

5. Divide the Cumulative Totals.

VWAP = Cumulative(Typical Price x Volume) / Cumulative(Volume)

 

The VWAP values are as follows:

1. On 2023-07-24:

   Typical Price = (3550.00 + 3400.00 + 3500.00) / 3 = 3483.33

   VWAP = (3483.33 * 100,000) / 100,000 = 3483.33

2. On 2023-07-25:

   Typical Price = (3600.50 + 3500.50 + 3550.50) / 3 = 3550.50

   VWAP = ((3483.33 * 100,000) + (3550.50 * 120,000)) / (100,000 + 120,000) ≈ 3516.67

3. On 2023-07-26:

   Typical Price = (3600.75 + 3550.75 + 3575.75) / 3 = 3575.42

   VWAP = ((3483.33 * 100,000) + (3550.50 * 120,000) + (3575.42 * 150,000)) / (100,000 + 120,000 + 150,000) ≈ 3541.67

4. On 2023-07-27:

   Typical Price = (3600.20 + 3522.20 + 3562.20) / 3 = 3561.87

   VWAP = ((3483.33 * 100,000) + (3550.50 * 120,000) + (3575.42 * 150,000) + (3561.87 * 130,000)) / (100,000 + 120,000 + 150,000 + 130,000) ≈ 3540.53

5. On 2023-07-28:

   Typical Price = (3600.40 + 3520.40 + 3520.40) / 3 = 3547.07

   VWAP = ((3483.33 * 100,000) + (3550.50 * 120,000) + (3575.42 * 150,000) + (3561.87 * 130,000) + (3547.07 * 110,000)) / (100,000 + 120,000 + 150,000 + 130,000 + 110,000) ≈ 3541.28

Interpretation:

- The VWAP represents the average price of all trades weighted by their respective volumes.

- If the current price of TCS is above the VWAP, it suggests that the stock's current price is relatively strong compared to the average traded price, which may be considered bullish.

- Conversely, if the current price of TCS is below the VWAP, it suggests that the stock's current price is relatively weak compared to the average traded price, which may be considered bearish.

As with any technical indicator, it's essential to use VWAP in conjunction with other tools and analyses to make well-informed trading choices. Additionally, historical performance is not indicative of future results, so prudent risk management is always crucial when trading or investing in the stock market.

 

Practical Applications of VWAP

1. Execution and Benchmarking: VWAP is widely used by institutional traders for executing large orders while minimizing market impact. Traders can compare the execution price of their trades with the VWAP to assess the effectiveness of their order execution and identify potential slippage.

2. Market Analysis: VWAP serves as a reference point to gauge the fair value of a security. By comparing the current price of a security to its VWAP, traders can identify whether the price is trading above or below the average for the day, indicating potential overvaluation or undervaluation.

3. Trend Identification: VWAP can help traders identify the prevailing intraday trend. When the price is consistently trading above the VWAP, it suggests a bullish sentiment, while prices consistently trading below the VWAP indicate a bearish sentiment. Traders can use this information to align their trading strategies with the prevailing trend.

4. Support and Resistance Levels: VWAP can act as a support or resistance level for a security. When the price approaches the VWAP from below and bounces off, it may indicate a support level. Conversely, when the price approaches the VWAP from above and finds resistance, it may indicate a potential resistance level.

5. Risk Management: Traders can use VWAP as a benchmark for setting stop-loss orders. Placing a stop-loss order slightly above or below the VWAP can help manage risk by providing a reference point that considers both price and volume dynamics.

Conclusion

Volume Weighted Average Price (VWAP) is a powerful technical indicator that incorporates both price and volume data to provide traders with valuable insights into market dynamics. By using VWAP, traders can gauge the fair value of a security, identify trends, analyze support and resistance levels, manage risk, and make more informed trading decisions. It is important to note that VWAP is most effective in intraday trading and should be used in conjunction with other technical indicators and analysis tools to build a comprehensive trading strategy. As with any indicator, thorough backtesting and validation are recommended to ensure its effectiveness in different market conditions.

Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. ( Member Code : 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701000, E-mail address: complianceofficer@icicisecurities.com. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The client shall not have any claim against I-Sec and/or its employees on account of any suspension, interruption, non-availability or malfunctioning of I-Sec system or service or non-execution of algo orders due to any link/system failure for any reason beyond I-Sec control. I-Sec reserves the right to pause, stop or call back any of the execution algos in case of any technical or mechanical exigency.