# Volume-Weighted Average Price (VWAP): What is It & Why It's important for Investing

By Chika

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Last Updated: March 25, 2022

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There are a plethora of metrics that traders use to find patterns in the market and guide their trading strategies. One key metric traders look out for when identifying market trends is volume

Assessing volume within time ranges is regarded as technical analysis. This is because it enables traders to gauge the strength of a price action, positioning their trades accordingly.

• points of support or resistance at certain price thresholds
• price trends
• and more

One of the technical indicators which traders use to decipher market volume is VWAP Scanner. When used as a broader trend confirmation strategy, it helps traders identify liquidity points and determine the target price for a particular asset.

In this article, we will explain how the Volume-Weighted Average Price (VWAP) can be used to complement your technical analyses allowing you to make profitable trades.

## What is VWAP and How Do You Calculate it?

The volume-weighted average price (VWAP) is a technical indicator used to determine the average price of a security based on the volume traded.

It's calculated by:

• summing up the total amount of money exchanged in each transaction (price multiplied by the number of shares traded)
• then dividing by the total number of shares traded within the specified timeframe (i.e 15 mins, 1-hour, 4-hour, or daily timeframe).

For example, to calculate the VWAP of stock on the daily chart, the first step is calculating the average price.

### VWAP Formula

This is obtained by adding the high, low, and closing price of the stock for that day and dividing by the number of values (3). i.e. (H+L+C)/3, if H = 25 , L = 18 and C = 22, the average price is:

Typical Price = (25+18+22) / 3 = 21.67

Next, you need to multiply the typical price by the volume. If V = 20, then:

21.67 * 20 = 433.4

You can keep a running total of the volume as they aggregate through the day to give you the cumulative volume. The cumulative volume, in our example, is 78.

Therefore, using the VWAP formula above:

VWAP = 433.4 / 78 = 5.55

However, you do not need to perform these calculations manually. There is software that can be used to calculate the VWAP. All the investor needs to do is specify the number of timeframes they intend to use in the VWAP calculation.

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## 3 Benefits of Using VWAP

Most experts believe the VWAP is more reflective of a genuine average price of the stock since it integrates price and volume in its value. Because it is based on previous data, the VWAP is considered to be a lagging indicator, which makes it perfectly suited for short timeframes.

The benefits of using VWAP are as follows:

### 1. Helps in determining the market value of a stock

The VWAP helps investors and traders to ascertain if a stock's current market price is overpriced or underpriced. This is in comparison to the average trading price during the timeframe under consideration.

### 2. Helps to determine the trend of a security

Because it deals with trend and momentum, the VWAP Scanner provides insight on the trend of a security. It can be used to indicate if the price action of an asset is bullish or bearish.

The price action on a security can be said to be bullish when the price is above the VWAP line and bearish if the price is below the VWAP line.

### 3. Can be used to time entry and exit

VWAP is a useful tool for making trading decisions based on entry or exit a given security. Investors and traders would normally buy when the stock price is below VWAP, and vice versa.

For example, if a hedge fund wants to acquire thousands of shares, below the average price for the day, it can use the VWAP to determine its entry price level. This can help make investors post more profitable trades.

## How is VWAP Used in Trading?

To use Volume-Weighted Average Price effectively in trading, there are certain metrics you have to take note of.

Average price, the volume of shares, and timeframe.

To find the average price, see the calculation above.

After you have obtained these metrics, you can use software to calculate the VWAP. Once you are satisfied with your calculations, you can use the VWAP scanner to ascertain the trend of the security.

Depending on your chart platform, VWAP Scanners can be created by adding the chart of your desired security to the VWAP scanner or by clicking the VWAP indicator. This will automatically add the VWAP indicator to your chart.

You can set a notification to alert you when the price goes below or above the VWAP line depending on your trading strategy.

Algorithm traders usually infuse a certain percentage below or above the VWAP line before the trade executes or they are notified.

Some experienced traders use a VWAP crossover strategy to detect reversals in a timely fashion. The basic idea in crossover strategies is to use a “fast” average to gauge trend direction when it crosses over a “slow” average.

For example, your VWAP crossover strategy can include setting your fast-moving VWAP line between 1-3 periods. Your slow-moving VWAP line to around 5-10 periods.

## How to Use the VWAP Scanner

VWAP is best used in combination with other technical indicators.  By using multiple other indicators with VWAP, technical analysis improves because you can confirm a trend in many ways.

### The VWAP scanner is often used in conjunction with the Moving Average Convergence Divergence (MACD) by certain traders.

A bullish crossover of the MACD lines at the same time as prices get overextended to the downside beneath the VWAP line might signal a buying opportunity.

If the MACD indicates a bearish crossover when prices are much above the VWAP line, it may be a good moment to exit a trade or open a short position.

### In the same vein, the VWAP scanner can be used in combination with Bollinger Bands.

These are a set of trendlines that may be changed to user preferences and are drawn two standard deviations (positively and negatively) away from a simple moving average (SMA) of a security's price.

Traders can use a VWAP signal to initiate a trade and then exit it using a Bollinger Band signal, or vice versa.

The key here is that the VWAP scanner should not be used in isolation if you want a thorough analysis of the price action on a security. Combining it with other indicators improves your analysis and confirms trends.

### What is the Best Time Frame Setting for a VWAP Scanner?

Apart from using it for intraday periods, there is no set-in-stone number of timeframes that a trader can use in the VWAP scanner. However, it is recommended to use shorter periods for these averages since you are looking for momentum.

For example, your fast-moving VWAP line could be set between 1-3 periods. Your slow-moving VWAP line could be set between 5-10 periods.

## Key Takeaway on Volume-Weighted Average Price

The volume-weighted average price indicator gives information about price action and volume relating to one day. This makes it most helpful for intraday analysis. It’s one data point among many that traders might use when devising their investment strategy.

Photo by Adam Nowakowski on Unsplash

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