Volume Weighted Average Price (VWAP) is the average of the price and the volume.
It is an extremely important indicator that helps traders and investors gauge the trend and understand whether they bought or sold a stock at the right price. It also helps traders enter into profitable trades.
To understand how VWAP is calculated, let’s take an example:
Stock opened at 10 in the morning and is currently quoting 8 bucks (let’s say, buyer at 7.75, seller at 8.50).
So, as per charts it will show a sharp fall of 20% (from 10 to 8) and perhaps some indicators will signal a sell.
But, let us suppose the price movement went like this:
50,000 shares traded at 10
5,000 shares traded at 9
2,000 traded at 8
The VWAP will be calculated like this:
50,000 X 10 = 5,00,000
5,000 X 9 = 45,000
2,000 X 8 = 16,000
Total: 57,000 shares traded for 5,61,000
5,61,000 divided by 57,000 = 9.84. This is the VWAP.
Remember that different formulas may be used, but the end result is more or less what you read above.
So, the VWAP in this case is just 16 paise away from the opening price of Rs 10, whereas you will see a sharp dip on the charts (from 10 to 8) and possibly rush in to short the stock.
However, a VWAP watcher will not short the stock at 8 even if he is bearish.
Here is another example for better understanding:
This is the Syngene chart. The dark blue line is the VWAP.
Here is what we can observe and conclude:
Phase A: The price moved above the VWAP and later fell to meet the VWAP.
Phase B: The VWAP started rising and so did the price initially. Later the price started falling and so did the VWAP until both reconciled.
Phase C: The VWAP and price started rising but the price remained above or below the VWAP until both the values reconciled.
Advantages of using VWAP
- It helps traders cut through the noise generated by highs, lows, open, close, and 0ther candle formations, and benchmark the current price to the VWAP.
- The traders can figure easily out whether the volumes are being picked up (or sold) at low or high prices. He can figure out this information in just one glance.
- It helps traders buy or sell at the right price (the VWAP) instead of jumping into a trade at current prices.
- VWAP especially helps large traders such as MFs and institutions trade at an optimum price.
- Bulls and Bears can use VWAP to enter into intra day profitable trades.
VWAP Interpretation and Trading Strategies
- When price crosses above VWAP and the volumes are significant, it implies that bulls are in control (BUY if the volumes are significant).
- When price crosses above VWAP and the volumes are insignificant, it implies that the price may be being pushed up (Consider a SHORT if the volumes are insignificant).
- When price falls below VWAP and the volumes are significant, it implies that bears are in control (SELL if the volumes are significant).
- When price falls below VWAP and the volumes are insignificant, it implies that the price is being dragged down (Consider going LONG if the volumes are insignificant).
To understand these signals, let’s analyze this 1 Hour Chart of Wockhardt.
A – Price moves below VWAP and volumes are significant (SHORT)
B – Price moves below VWAP and volumes are not significant (AVOID)
C – Price moves below VWAP with good volumes (SHORT)
D – Price moves above VWAP, volumes are significant, and selling is rejected (candle) (LONG)
E – Price moves above VWAP and volumes are insignificant (AVOID)
F – Price moves above VWAP and volumes are good (LONG)
This is all you need to know about VWAP.