VWAP (Volume Weighted Average Price) is a widely used trading metric that represents the average price of a security, weighted by the volume traded at each price level throughout a trading day. Unlike a simple average price, which treats every trade equally regardless of size, VWAP accounts for how much volume occurred at each transaction price, offering a more accurate reflection of the true average price at which a security traded.

Formula:
VWAP = (Sum of Price × Volume) / (Sum of Volume)
Or more specifically, for each trade or time interval i:
VWAP = (∑(P_i × V_i)) / (∑V_i)
Where P_i is the price of trade i and V_i is the volume of trade i.

Traders and institutions use VWAP as a benchmark for trade execution. For example, if a trader buys a stock below the VWAP, it is generally considered a good fill because they purchased shares at a price lower than the average price paid by the market during the day. Conversely, selling above the VWAP is seen as favorable. VWAP is often used by institutional traders who want to minimize market impact when executing large orders, ensuring they do not pay significantly more or receive significantly less than the average market price.

A practical example can help clarify this. Suppose a trader is looking at EUR/USD forex CFDs over the course of a trading day. Throughout the day, the EUR/USD price fluctuates between 1.1000 and 1.1050, but the volume at each price level varies. If the majority of volume trades at 1.1020, the VWAP will be closer to 1.1020 rather than the simple average of the highest and lowest prices. If a trader enters a long position at 1.1010, which is below the VWAP, it might indicate a favorable entry since the average market participant paid more for the currency pair during the day.

One common misconception about VWAP is that it is a predictive indicator. Some traders believe that price crossing above or below VWAP signals future price direction. In reality, VWAP is a lagging indicator because it is calculated from historical price and volume data accumulated throughout the trading day. It is best used as a benchmark or a reference point rather than a standalone trading signal.

Another mistake is using VWAP in isolation or across multiple days without resetting it daily. VWAP is designed specifically for intraday use and resets at the start of each trading session. Using VWAP values from previous days can lead to misleading conclusions about where the average price currently stands. For longer-term analysis, traders might use other volume-based indicators or moving averages instead.

People often search for related terms such as “VWAP trading strategy,” “VWAP vs moving average,” or “how to use VWAP in day trading.” While VWAP shares similarities with moving averages in smoothing price data, its unique volume weighting makes it more sensitive to the actual traded volume at different price levels. This makes VWAP especially useful for intraday traders looking to understand the real market consensus price.

In summary, VWAP is a valuable tool for traders who want to gauge the average price weighted by volume during the day, helping with execution decisions and understanding market sentiment. However, it should be used alongside other indicators and within its intended intraday context to avoid common pitfalls.