Why VWAP?

Even in its simplest form, incorporating VWAP into your trading can further your ability to understand and analyze the markets.

Institutional traders use VWAP every day

VWAP is a holistic, dynamic benchmark universally understood and applied by institutions, and is the most common benchmark used to determine transaction costs (and therefore, to judge institutional traders’ efficiency when executing a trade).

Institutional traders are — on a very fast and sophisticated level — tasked with achieving the most favorable dollar-cost average of their positions.  By contrasting trade execution (NOT the outcome of the trade, just the entry price) with the security’s true average price (VWAP), an institution can objectively gauge their traders’ performance.

But it’s not enough to merely know if an entry is above or below the benchmark — we need a consistent measurement of distance to the VWAP.  Standard deviation bands are the most logical metric for this task — we can’t use dollar-distance (because some stocks are huge, and some are small), we can’t use percent-distance (because some stocks typically move significantly, and others rarely do).  Standard deviations are a statistically valid method of gauging distance from the mean of a dataset, which in this case is price’s distance from VWAP.

Because institutional traders are using this consistent benchmark and consistent distance measurement from said benchmark, we watch the same levels for otherwise hidden support and resistance.  Simply put, if your job (or bonus) were dependent on performance relative to VWAP — wouldn’t you watch it closely, too?"

Cumulative, not periodic

When you think about a market’s average price, are you *ever* asking that question with a fixed periodicity? That is to say, are you ever asking yourself “What is the average price over the last twenty bars?”

Odds are, you’re asking yourself a cumulative question — “What’s the average price of this stock for the day?” — without respect to any silly, arbitrary number of bars. That’s because the human brain thinks in terms of cumulative questions (such as “How have you been since we last saw each other?”, not “How have you been for the last 20/50/200 hours?”). Nearly every other indicator is periodic (looking back at a fixed number of bars), despite the intuitive nature of something cumulative like VWAP.