Day traders can use many strategies and indicators to make decisions. Among the most popular is volume-weighted average price (VWAP). This blog post will look at VWAP and how day traders can use it.
What is the Volume-weighted Average Price?
Volume-weighted average price (VWAP) is a trading benchmark used by traders. It is the average security price over time weighted by the volume traded in that period. VWAP is also a default order type on many electronic trading platforms.
How to Calculate VWAP
To calculate VWAP, you’ll need three things: the total number of shares traded, the total value of those shares traded, and the length of time over which you want to calculate the VWAP.
Here’s the formula:
VWAP = (Number of shares traded * Share price) / Total number of shares traded
For example, let’s say you want to calculate the VWAP for a stock over five days.
- On day one, 100 shares were bought at $10 per share.
- On day two, 200 shares were bought at $20 per share.
- On day three, 300 shares were bought at $30 per share.
- On day four, 400 shares were bought at $40 per share.
- And on day five, 500 shares were bought at $50 per share.
The calculation would look like this:
VWAP = ((100*10)+(200*20)+(300*30)+(400*40)+(500*50))/ (100+200+300+400+500)
Which equals $30.
Why Use VWAP?
Some traders use VWAP as an objective way to assess whether a stock is undervalued or overvalued. Suppose the current market price is trading below the VWAP level. In that case, some traders may view this as an opportunity to buy the stock while it is undervalued. Conversely, suppose the current market price is trading above the VWAP level. In that case, some traders may view this as an opportunity to sell short the stock while it is above. Of course, other factors should be considered before taking any trade action.
Another potential benefit of using VWAP is that it can help avoid “price slippage.” Price slippage occurs when an order to buy or sell a stock is not filled at the expected price due to market conditions. For example, if you place an order to buy 100 shares of XYZ stock at $10 per share, but XYZ stock trades at $10.05 per share by the time your order gets filled, then you have experienced 5 cents per share in price slippage. Using VWAP can help avoid situations like this because orders placed using VWAP will generally be filled closer to the VWAP price than the current market price.
In conclusion, the volume-weighted average price (VWAP) is a valuable tool that day traders can use for making trading decisions. It’s important to remember that VWAP should only be one part of your overall trading strategy. It’s not a guarantee of success, and there are always risks involved with any investing or trading activities.