What it means
The volume-weighted average price gives more importance to prices at which lots of shares changed hands. It is calculated from the open of the trading day and updates continuously.
Because it reflects where most of the business was done, it is treated as a fair price benchmark for the day. Many traders use VWAP as a dividing line.
When the price is above VWAP, buyers have generally been paying more than the day's average, which suggests strength. When the price is below it, sellers have the upper hand.
A VWAP cross occurs when the price moves from below to above, a bullish cross, or from above to below, a bearish cross. Day traders often treat a bullish cross, especially with rising volume, as a possible buy signal.
A bearish cross is read as a possible sell signal or a reason to reduce a position. Large institutions use VWAP differently.
A fund buying a big block of shares tries to execute at or below VWAP so that it can show it got a fair price, and its trading algorithms spread orders through the day for that purpose. This activity is one reason the price often reacts around the VWAP line.
The signal has limits. VWAP resets each day, so a cross early in the session is based on little data and can be unreliable.
In choppy markets, the price may cross many times without any lasting move, which can trigger repeated false signals. For a finance reader, the useful point is that VWAP is both a trading signal and a benchmark for execution quality.
Comparing the price a trade achieved with VWAP is a standard way to judge whether a broker did a good job.
In practice
Real-world examples.
Example
A day trader watches a share open weak and drift below VWAP. Late in the morning it rises through VWAP on heavy volume, so she buys, setting a stop just below the line. The price continues higher for the rest of the session.
Example
A fund manager needs to buy 300,000 shares of a mid-sized company. His broker is told to aim for VWAP, so it spreads the purchase over the day. At the close, the average price paid is $0.03 below VWAP, which the fund records as good execution.
Example
A trader holds a long position when the price falls through VWAP on rising volume. She treats it as a bearish cross and sells half the position. The price recovers later, showing the risk of reading a single cross as a firm signal.
Formula
Calculation
VWAP = Sum of (Price x Volume) / Sum of Volume
During the morning, a stock trades 1,000 shares at $50, 2,000 shares at $51 and 1,000 shares at $52. Total value = (1,000 x $50) + (2,000 x $51) + (1,000 x $52) = $50,000 + $102,000 + $52,000 = $204,000. Total volume = 1,000 + 2,000 + 1,000 = 4,000 shares. VWAP = $204,000 / 4,000 = $51.00. If the price then rises from $50.80 to $51.20, it has made a bullish cross of VWAP.Case study
Seen in the real world.
Thornbury Asset Management is an illustrative, fictional fund that studied how its traders used VWAP crosses. The head of trading reviewed 200 trades over six months and compared outcomes for entries made on a cross with those made without a signal.
Trades entered after a bullish cross with above-average volume earned a little more on average than other entries, but many early-morning crosses reversed within an hour. The analysis showed that crosses in the first 30 minutes were unreliable.
The firm adopted a rule to ignore crosses before 10:00 and to demand a volume confirmation. The illustrative lesson is that the signal is a tool for timing, not a guarantee, and its usefulness depends on the rules around it. The head of trading also began comparing each large order's average price with VWAP in a monthly report, so that execution quality could be discussed with brokers using actual numbers. Over two quarters the report showed that orders spread through the day beat VWAP more often than orders placed all at once.
Watch out
Common mistakes.
- Trusting a VWAP cross early in the trading day, when the average is based on very little data.
- Applying VWAP across multiple days as though it were a continuous line, when it normally resets at each open.
- Treating every cross as a trade signal without checking volume or the wider trend.
Questions
People also ask.
What is VWAP?
It is the average price of a security over a period, weighted by the volume traded at each price.
Why do institutions care about VWAP?
It is a benchmark for judging whether a large order was executed at a fair price during the day.
Does a cross mean the price will keep moving?
Not necessarily, as in sideways markets the price can cross many times without a lasting trend.
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