VWAP
Encyclopedia
In finance, volume-weighted average price (VWAP) is the ratio of the value traded to total volume
traded over a particular time horizon (usually one day). It is a measure of the average price a stock
traded at over the trading horizon.
VWAP is often used as a trading benchmark
by investors who aim to be as passive as possible in their execution. Many pension fund
s, and some mutual fund
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 volume on the market. It is sometimes argued that such execution reduces transaction costs by minimizing market impact
(the adverse effect of a trader's activities on the price of a security
).
VWAP can be measured between any two points in time but is displayed as the one corresponding to elapsed time during the trading day by information provider.
VWAP is often used in algorithmic trading
. Indeed, a broker
may guarantee execution of an order at the VWAP price and have a computer program enter the orders into the market in order 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 to the client 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.
where:
= Volume Weighted Average Price
= price of trade j
= quantity of trade j
= each individual trade that takes place over the defined period of time, excluding cross trades and basket cross trades.
Volume
Volume is the quantity of three-dimensional space enclosed by some closed boundary, for example, the space that a substance or shape occupies or contains....
traded over a particular time horizon (usually one day). It is a measure of the average price a stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
traded at over the trading horizon.
VWAP is often used as a trading benchmark
Benchmarking
Benchmarking is the process of comparing one's business processes and performance metrics to industry bests and/or best practices from other industries. Dimensions typically measured are quality, time and cost...
by investors who aim to be as passive as possible in their execution. Many pension fund
Pension fund
A pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s, and some mutual fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
s, fall into this category. The aim of using a VWAP trading target is to ensure that the trader
Trader (finance)
A trader is someone in finance who buys and sells financial instruments such as stocks, bonds, commodities and derivatives. A broker who simply fills buy or sell orders is not a trader, as they are merely executing instructions given to them. According to the Wall Street Journal in 2004, a managing...
executing the order does so in-line with volume on the market. It is sometimes argued that such execution reduces transaction costs by minimizing market impact
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 selling...
(the adverse effect of a trader's activities on the price of a security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
).
VWAP can be measured between any two points in time but is displayed as the one corresponding to elapsed time during the trading day by information provider.
VWAP is often used in algorithmic trading
Algorithmic trading
In electronic financial markets, algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading, is the use of electronic platforms for entering trading orders with an algorithm deciding on aspects of the order such as the timing, price, or quantity of the...
. Indeed, a broker
Broker
A broker is a party that arranges transactions between a buyer and a seller, and gets 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...
may guarantee execution of an order at the VWAP price and have a computer program enter the orders into the market in order to earn the trader's commission
Commission (remuneration)
The payment of commission as remuneration for services rendered or products sold is a common way to reward sales people. Payments often will be calculated on the basis of a percentage of the goods sold...
and create P&L. This is called a guaranteed VWAP execution. The broker can also trade in a best effort way and answer to the client 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.
Formula
VWAP is calculated using the following formula:where:
= Volume Weighted Average Price = price of trade j = quantity of trade j = each individual trade that takes place over the defined period of time, excluding cross trades and basket cross trades.