Investors are constantly tracking the price of stocks and other securities that they trade. Many stock exchanges report the price of a security as the price at which the most recent trade occurred, but there are other ways to track a security’s price.
Volume-weighted average pricing (VWAP) is one method of tracking a security’s price. It takes into account the number of shares that changed hands at specific prices.
Definition and Example of Volume-Weighted Average Pricing
Volume-weighted average pricing looks at the average price at which a security is traded during a period. This is in contrast to the pricing method, which simply reports the price at which the most recent trade occurred.
VWAP is a popular tool for technical analysis. It’s also a favored benchmark for passive investors who want to determine whether they’re trading a stock at a good price.
Note: Technical analysis relies on examining stock charts to try to identify patterns and then using those patterns to predict future stock performance.
To calculate VWAP, you can use this formula:
The sum of (number of shares traded x the price they were traded at) / total number of shares traded that day
VWAP has been likened to moving averages by technical analysts because it changes more slowly than the stock’s price. Some analysts see prices above the VWAP as indicating an uptrend and prices below the VWAP as pointing to a downtrend.
How Volume-Weighted Average Pricing Works
Volume-weighted average pricing works by letting investors find the average price at which a stock or other security is traded during the course of the day.
Imagine that during one trading day, five shares of XYZ changed hands. In the morning, two shares traded at $10 each. In the early afternoon, two shares traded at $7 each, and just before the market closed, one share traded at $12.
This would result in most quotes for XYZ showing its price as $12 because that is the price at which the most recent trade happened.
But the VWAP for the day would be $9.20 because that was the average price paid for a share on that day. The formula to find that VWAP in this instance is:
($10 + $10 + $7 + $7 + $12) / 5 shares traded = $9.20 volume-weighted average price
Pros and Cons of VWAP
Good for analyzing the price of large stock transactions
The measure is less reactive to short-term volatility
The large amount of data points makes it hard to calculate
Limited use outside of large investments and technical analysis
- Good for analyzing the price of large stock transactions. If you’re buying or selling a large amount of a security, your order may have an impact on the price of the stock. Using VWAP, you can get a better idea of how much you’re affecting a stock’s price and whether you’re getting a good deal.
- The measure is less reactive to short-term volatility. Stocks can regularly experience volatility, which can cause big spikes or drops in price if you’re only looking at the price of the most recent transaction. VWAP smooths out the volatility, providing a clearer indication of a stock’s price direction.
- The large amount of data points makes it hard to calculate. Some popular securities, like stocks of blue-chip companies, see millions of shares change hands each day. To figure VWAP, you’ll need a way to do calculations using these million or more data points.
- Limited use outside of large investments and technical analysis. Unless you’re a huge investor who’s using VWAP to analyze your positions or a technical analyst trying to identify buy and sell signals, VWAP won’t be very useful. Investors trading just a handful of shares will want to focus more on the market price for the security.
What it Means for Individual Investors
Most investors won’t need to worry about VWAP because their portfolios are too small to make it a good way to analyze the value of their stock positions. If you’re implementing technical analysis in your investing strategy, you may want to use VWAP to try to identify trends. Otherwise, most individual investors can safely ignore it.
- VWAP measures the average price at which a security is traded during a period.
- VWAP tends to change more slowly than a stock’s market price, meaning it smooths out short-term volatility in price.
- It is commonly used in technical analysis and by investors and institutions with large portfolios.