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In finance, volume-weighted average price (VWAP) is the ratio of the value of a security or
financial asset A financial asset is a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and participations in companies' share capital. Financial assets are usually more liquid than other tangible assets, such as ...
traded to the total
volume Volume is a measure of occupied three-dimensional space. It is often quantified numerically using SI derived units (such as the cubic metre and litre) or by various imperial or US customary units (such as the gallon, quart, cubic inch). The de ...
of transactions during a trading session. It is a measure of the average trading price for the period. Typically, the indicator is computed for one day, but it can be measured between any two points in time. VWAP is often used as a trading
benchmark Benchmark may refer to: Business and economics * Benchmarking, evaluating performance within organizations * Benchmark price * Benchmark (crude oil), oil-specific practices Science and technology * Benchmark (surveying), a point of known elevati ...
by investors who aim to be as passive as possible in their execution. Many
pension fund A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed and priva ...
s, and some
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...
s, fall into this category. The aim of using a VWAP trading target is to ensure that the trader executing the order does so in line with the volume on the market. It is sometimes argued that such execution reduces
transaction costs In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
by minimizing
market impact cost In financial markets, market impact is the effect that a market participant has when it buys or sells an asset. It is the extent to which the buying or selling moves the price against the buyer or seller, i.e., upward when buying and downward when ...
s (the additional cost due to the
market impact In financial markets, market impact is the effect that a market participant has when it buys or sells an asset. It is the extent to which the buying or selling moves the price against the buyer or seller, i.e., upward when buying and downward when ...
, i.e. the adverse effect of a trader's activities on the price of a
security Security is protection from, or resilience against, potential harm (or other unwanted coercive change) caused by others, by restraining the freedom of others to act. Beneficiaries (technically referents) of security may be of persons and social ...
). VWAP is often used in
algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...
. A
broker A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be confu ...
may guarantee the execution of an order at the VWAP and have a computer program enter the orders into the market to earn the trader's commission and create P&L. This is called a guaranteed VWAP execution. The broker can also trade in a best effort way and answer the client with the realized price. This is called a VWAP target execution; it incurs more dispersion in the answered price compared to the VWAP price for the client but a lower received/paid commission. Trading algorithms that use VWAP as a target belong to a class of algorithms known as ''volume participation algorithms''. The first execution based on the VWAP was in 1984 for the Ford Motor Company by James Elkins, then head trader at Abel Noser.


Formula

VWAP is calculated using the following formula: :P_ = \frac \, where: :P_ is Volume Weighted Average Price; :P_j is price of trade j; :Q_j is quantity of trade j; :j is each individual trade that takes place over the defined period of time, excluding cross trades and basket cross trades.


Using the VWAP

The VWAP can be used similar to moving averages, where prices above the VWAP reflect a bullish sentiment and prices below the VWAP reflect a bearish sentiment. Traders may initiate short positions as a stock price moves below VWAP for a given time period or initiate long positions as the price moves above VWAP. Institutional buyers and algorithms often use VWAP to plan entries and initiate larger positions without disturbing the stock price. VWAP slippage is the performance of a broker, and many Buy-side firms now use a Mifid wheel to direct their flow to the best broker.


See also

*
Electronic trading In finance, an electronic trading platform also known as an online trading platform, is a computer software program that can be used to place orders for financial products over a network with a financial intermediary. Various financial products c ...
*
Time-weighted average price In finance, time-weighted average price (TWAP) is the average price of a security over a specified time. TWAP is also sometimes used to describe a TWAP card, that is a strategy that will attempt to execute an order and achieve the TWAP or better. ...


References

{{Reflist Mathematical finance Stock market Algorithmic trading