VWAP explained: calculation and use in intraday trading

In short

• VWAP stands for Volume Weighted Average Price: the day’s average price, where trading with high volume counts for more.
• It is a line on your chart that starts at the open of the trading day. Traders use it as a reference: is the price above or below it?
• VWAP is a tool for reading the market. It predicts nothing and gives no buy or sell signal that is certain to be right.
• When you trade often, spread, commission and slippage count. Always use a stop-loss and a maximum loss per day.

What is VWAP?

VWAP is an indicator for intraday trading. That means trading within a single day. The indicator shows the average price at which trading took place that day. A price at which a lot was traded counts for more than a price at which little was traded.

That is the difference from a plain moving average. A moving average only looks at prices. VWAP also looks at volume: the number of units traded.

Key features:

• It restarts every trading day. On a daily or weekly chart it therefore has no meaning.
• It becomes slower as the day goes on. At the start it moves quickly with the price. Later the average contains many more data points and it moves less.
• It works best for instruments with a lot of trading and reliable volume. On markets without central volume data, such as many currency markets, VWAP is less useful.

Worked example

This example is made up and uses simplified numbers. A trading platform calculates per transaction or per small time unit, but the principle is the same.

The formula is: VWAP = (sum of price × volume) divided by (sum of volume).

Suppose you look at the first three five-minute periods, with the average price per period:

The plain average of the three prices is €50.20. The VWAP is €50.27, because the period with the highest price also had the most volume. The average is therefore pulled further toward that price.

How do traders use VWAP?

Traders use VWAP in several ways. These are descriptions, not recommendations.

As a reference for the day

If the price is above VWAP, buyers that day have on average paid higher prices than the day’s average. Some traders read that as strength. If the price is below, they read it as weakness. This is an interpretation, not an established fact.

As a level to watch

Sometimes the price turns at the VWAP line, and sometimes it cuts straight through. Some traders therefore watch the line as a possible support or resistance level. See the tutorial on support and resistance for the basics.

A commonly described approach, as an example:

1. The price is above VWAP and moving up.
2. The price falls back to the VWAP line.
3. The trader waits until the price visibly moves up again and only then enters.
4. The stop-loss sits just below the VWAP line or below the latest low.

For a falling price below VWAP, the reverse applies. Here too the price may move differently than expected.

As a measure of execution

Some large participants compare their average purchase price with the day’s VWAP. They want to know whether they bought better or worse than the daily average. For an individual trader this is mainly useful as background.

Limitations

• It looks backward. VWAP is an average of what has already happened. It does not say what the price will do next.
• Quiet markets. If the price hovers around the line all day, it produces many false signals.
• News. A major news item can send the price far from VWAP. The line does not predict that.
• The start of the day. In the first minutes there is little data. The line is unreliable then.
• One indicator is not much. At most, combine it with volume analysis or the trend on a higher timeframe.

Common mistakes

• Treating every touch of the line as a signal. Many touches lead nowhere.
• Not using a stop-loss because “the price will come back on its own”.
• Using VWAP on a daily or longer chart. It is meant for a single trading day.
• Trading too early. Right after the open the line is still unreliable and spreads are wider.
• Too many trades. More trades mean more costs.

Risk management

An indicator does not protect you from losses. Your own rules do.

1. Risk per trade. Decide in advance the most you are willing to lose, for example a small percentage of your account. Calculate it with the risk-per-trade tool.
2. Position size. It follows from the risk amount and the distance to your stop-loss. Use the position size calculator.
3. Maximum loss per day. Choose a limit. If you reach it, you stop for the day.
4. Keep records. Note your trades and costs in a trading journal and test your rules first with paper trading or on historical data (backtesting).

A stop-loss gives no certainty about the execution price. In a fast price jump the fill can be worse than your stop.

Costs of frequent trading

Intraday trading often means several trades a day. Every trade costs money:

• Spread: the difference between bid and ask. You pay it on every trade.
• Commission: what your broker charges per order. See trading costs.
• Slippage: the difference between the expected and the actual execution price.

A price move of a few cents can be largely eaten up by these costs. Brokers differ in costs. Compare them based on how many trades you expect to make. You can start with the comparison tool. Treat it as a starting point, not as advice.

Summary

• VWAP is the volume-weighted average price of the day and restarts every day.
• You calculate it as the sum of price × volume divided by the sum of volume.
• Traders use it as a reference for strength or weakness and as a level to watch. It is not a certainty.
• It looks backward, works poorly in quiet markets and around news, and can give false signals.
• Use a stop-loss, a fixed position size and a maximum loss per day, and account for costs.

This article is educational and not investment advice. Trading involves risk, and you can lose all or part of your money.