The Ultimate Guide to VWAP

Volume-weighted average price [VWAP] is a technical indicator that calculates and displays a market's average transaction price for however long it's plotted.

Put simpler, VWAP represents the market's true average price for a certain period of time — most commonly from the start of a trading session until the end. By adjusting for volume, it more accurately reflects the impact of larger trades than traditional moving averages.

Despite its rise in popularity among retail traders in recent years, VWAP is still frequently underused and misapplied by most. This guide discusses additional applications of VWAP that often go overlooked — standard deviation bands, anchored VWAPs, and more — as well as addressing several misconceptions about how it should be used.

How is VWAP calculated?

Mathematically, VWAP is the total amount of money transacted divided by the total amount of volume — either shares or contracts — over the same timeframe.

Think of it as the dollar-cost average of an individual position held in your portfolio, but extrapolated to include everyone trading a given security instead of just your transactions. Consider the following example:

If only a single share of volume was transacted at each price, the average would have been $107.50. However, the volume-weighted aspect of VWAP drags the average higher to $109.29 due to the disproportionately larger volume at higher prices.

In reality, the calculated value of a VWAP incorporates the volume and price of every recorded transaction over the duration for which it's plotted.

It’s also important to note that VWAP is a cumulative calculation, rather than periodic. This means that it builds upon itself as time progresses, incorporating new price and volume data as it develops without leaving "old" data behind. We’ll discuss the importance of this detail later on in the guide.

How is VWAP used?

The use of VWAP has evolved over time, but it’s been widely utilized by institutional trading firms for decades — originally serving as an execution benchmark.

Fulfilling sizable client orders while minimizing market impact often requires trades to be broken down into several smaller transactions. The dollar-cost average of those collective transactions could then be compared to the VWAP over the acquisition timeframe to assess its quality.

“Did you get a good buy price on those 200,000 shares of XYZ?” could be responded to with, “Yeah, a few cents below the VWAP measured from when that order came in” — evidence that the filling broker did a good job of buying intelligently and opportunistically, rather than merely chasing the stock up and entering at a disadvantageous price.

The introduction of automated execution and profit-generating algorithms centered around VWAP have further solidified its importance and impact, as well as an increasing number of retail traders that now utilize it as a technical indicator.

Core Concepts to Know

There are a few key things about VWAP that we believe all traders should know, and they simultaneously address some of the most common misconceptions and FAQs we receive.

To use an analogy, think of a chart as a portrait drawn candle-by-candle. Imagine if you could only see the last 9, 20, or 50 brushstrokes made by the artist while everything painted beforehand disappears from view as they progress.

This is the limitation of periodic indicators. Any data from beyond the arbitrary lookback period you select — i.e., a 20-period simple moving average — is no longer factored into the indicator’s calculation, leaving you with an incomplete picture of the market.

VWAP’s calculation is cumulative, anchoring to a specific point and building upon itself over time. No piece of data gets left behind, providing you with a start-to-finish view of the portrait as it develops. Each transaction that occurs should factor into how we interpret the current state of the market and what’s more likely to happen next.

In addition to the increased context it provides, the cumulative calculation of VWAP also prevents confusion regarding chart time frames and settings — unlike moving averages or other periodic technical indicators.

Using a 20-period simple moving average on a 1-minute chart versus a 10-minute chart will produce noticeably different values, but this is not the case with VWAP. If using the proper calculation, the value of VWAP will remain constant regardless of the aggregation period.

It will always represent total money divided by total volume, no matter how you organize that data. There is ultimately only one true VWAP over any defined period of time.

One of the most commons myths about VWAP is that price is always attracted to it. This is false, and such interpretation leads to an oversimplified approach of “short anything above VWAP and buy anything below” with the expectation that a reversal is imminent.

If this were true, we’d never witness any sustained intraday trends. The reality is more nuanced. Price can be drawn towards VWAP in some instances, but it can also be actively repelled away from it in others.

Being able to distinguish between those two environments is crucial, and it’s something we touch on in one of our freely available video lessons.

By adjusting for volume in its calculation, VWAP is inherently more responsive to price movements with significant volume versus those that occur with less. And as VWAP incorporates more and more transaction data over time, its cumulative nature also makes it more resistant to random oscillations and sudden shifts.

Collectively, these two components bolster its credibility as a more objective reference point that can not be easily manipulated — only responding more aggressively when real, substantive amounts of money are moving the market.

We call this the "inertia" of VWAP, making it more steadfast and reliable than other short-term indicators that may spit out theoretical buy/sell signals every couple of minutes.

VWAP is an Event-Driven Average

The underlying idea behind VWAP is the launching of a cumulative, volume-weighted average from an anchored starting point. And although it’s most commonly implemented as an intraday indicator plotted from market open to market close, limiting VWAP to this singular application is a big mistake.

Instead, we view volume-weighted average price as an “event-driven average” with significantly more use cases. The open of a new trading session is one of the possible events that we can utilize as an anchor point, but that’s only scratching the surface.

At TheVWAP, we use a set of custom indicators to actively explore the use of anchored VWAPs with both longer-term and shorter-term durations. These anchor points include, but are not limited to:

• Macroeconomic reports
• Earnings releases
• Overnight gaps
• High-volume occurences
• Notable highs/lows

The way we implement and interpret these anchored VWAPs is not always the same as the ways in which we utilize intraday VWAP, but they play a unique and significant role in our framework in their own right.

VWAP and Standard Deviation Bands

Without a suitable metric to measure the current distance between price and VWAP, we’re left with a drastically oversimplified evaluation method — “are we above or below?”

The solution? Standard deviations are an objective, statistical measurement that are used to quantify the amount of variation in a data set. Smaller values indicate that most data points are close to the calculated average, while larger values indicate a wider range.

By applying this concept with all transactions serving as the data set and VWAP as its average, we can calculate and plot standard deviations as bands on our chart to create a visible unit of measurement. And through the use of these bands, we can characterize market movement in relation to VWAP and gauge the volatility of any traded instrument.

Standard deviations succeed where dollar and percent measurements cannot, standardizing volatility across trading instruments of all sizes.

Consider the chart examples of SPY and COP found below. Despite the vastly different closing prices of each ($431.85 for SPY and $34.06 for COP), applying intraday VWAP with the +/-1 and +/-2 deviation bands normalizes their volatility and allows us to analyze them through the same lens.

Standard deviation bands are plotted continuously alongside VWAP, automatically adjusting as more data is received — expanding or contracting as needed. The rate at which they do so depends on how far away from VWAP we trade and how much volume is being transacted when we do.

In the context of intraday VWAP, these dynamics will often result in standard deviation bands that gradually expand in trending environments and either remain stable or contract in consolidating environments.

Building a strategy around VWAP

Applying VWAP and its standard deviation bands to any chart creates a universally applicable grid system. Like lane markers on a road, we can use this grid to group market activity into distinct zones — each with a different set of unique characteristics and expectations.

Price crossing between these zones is often a noteworthy event, and in many cases the attempts to do so will be met with resistance. As a result, the barriers that separate them frequently serve as areas of technical support and resistance that otherwise go unseen.

By combining VWAP and deviation bands with overlaid anchored VWAPs, broader price patterns, and other analysis techniques we utilize, we can create an overarching framework that we use to answer several key questions, like:

Many traders view all charts as “long or short?”, but we believe that perspective is misguided. During periods of chop — aka random consolidation — there’s no discernible edge if you’re thinking directionally. Being able to distinguish between market types to help determine when you shouldn’t trade is arguably as important as knowing when you should.

If you’re interested in a trade, you now need to determine where it would make sense to enter. We look for several predetermined setups for this purpose, all based on the context of the chart and proximity to anticipated support or resistance levels. Patience is a virtue here.

Implementing an effective framework and strategy is important, but it doesn’t negate the need for risk management. Any trade you take should have a clear plan before you enter, including an understanding of where on the chart your idea will be proven wrong. That invalidation point should be your stop — not just a random price that you decide to use.

With your entry area and stop established, your risk is defined and your downside is protected. But you also need to know how to manage and maximize a position that moves in your favor. Identifying support or resistance levels in your path, partial profit-taking areas, and more — VWAP in its totality can be used for all of it.

Key Takeaways to Consider

At its core, the goal of incorporating technical analysis in your trading is to:

1. Analyze charts to find potential areas of opportunity that align with your goals.
2. Aim to enter a trade at a credible support/resistance level with defined risk and reward.
3. Monitor the likelihood of continuation vs reversal to best optimize your eventual exit.

When applied correctly, we believe volume-weighted average price and its often-overlooked applications — standard deviation bands, anchored VWAPs, slope, etc — can collectively satisfy all of these criteria.

It’s not the holy grail — no indicator or technical tool is. It won’t save you from undisciplined trading or poor risk management, but it can greatly simplify the process of identifying higher-quality opportunities and participating in them with a calculated and favorable risk/reward ratio.

Institutionally-recognized and statistically valid, VWAP should be a part of every technical trader’s set of tools. And to help you get started, here’s a few basic tips:

VWAP is effective on all kinds of different instruments, and we have members that trade stocks of all sizes, futures, cryptocurrencies, Forex, and bonds. However, the necessary caveat is that the markets you’re focusing on have sufficient liquidity — ideally on a consistent basis.

The less volume there is, the less reliable VWAP can become. Not to mention the broader issues with illiquid markets like wider bid-ask spreads and poor fills on executions.

In the majority of instances, VWAP is going to be less reliable during pre-market, the first 30 minutes of the session, and post-market.

Pre- and post-market activity often lacks sufficient liquidity, and the large influx of volume in the opening half our of the regular trading sessions leads to more random swings in the value of intraday VWAP while it begins to establish itself.

Like we mentioned earlier, it’s a mistake to assume that price has to return to VWAP. It’s an often-repeated myth that can quickly get you into trouble if you’re always looking to fade any moves above VWAP and bounce any moves below.

The reality is much more nuanced, and adding standard deviation bands can be a good starting point. To do so, try out the free custom indicator we provide.