Volume weighted average price (also abbreviated VWAP) is a formula used to calculate the average price a stock trades at, weighted by volume transacted at each price level. Normally traders are concerned with the volume weighted average price over a 1 day trading period, but some may be interested in longer or shorter term periods.
Day traders may track VWAP because this calculation is very significant to the trading of many mutual funds and most pension funds. When the current intra-day price varies significantly from the VWAP, there may be pressure for the price to move towards the VWAP.
This calculation is important to large passive institutional investors who are simply trying to match their average transaction price to the average price transacted over the course of a trading period. By matching the VWAP as closely as possible, they may reduce their market impact costs, which are the costs incurred by large traders whose trades are so large they move prices. They also reduce the risk that incorrect market timing will result in their average transaction value being significantly worse than what the market as a whole received.
How Volume Weighted Average Price is Calculated
Volume weighted average price is very simple to calculate. One takes the total value traded over the time period being analyzed, and divides by the total quantity traded.
VWAP = Quantity of Shares Bought at Each Price * Price of Each Transaction / Total Volume
Or more simply
VWAP= Total Value of All Transaction / Total Volume
Here is a simple example.
Transaction 1 = 100 shares at $10
Transaction 2 = 300 shares at $10.20
Total Value = (100* $10) + (300*$10.20) = $1000 + $3060 = $4060
Total Quantity = 100 + 300 = 400
VWAP = $4060 / 400 = $10.15
Practically speaking a trader could not keep track of VWAP in real time without computer calculating assistance. Many charting software packages do include VWAP tracking capabilities.