08 Dec What is VWAP – Volume Weighted Average Price?
In finance, the volume-weighted average price (VWAP) is the ratio of the value of a security or financial asset traded to the total volume of transactions during a trading session. It is a measure of the average trading price for the period.
Typically, the indicator is computed for a period of one day, but it can be measured between any two points in time.
This indicator is often used as a trading benchmark by investors who aim to be as passive as possible in their execution. Many pension funds, and some mutual funds, fall into this category. The aim of using a VWAP trading target is to ensure that the trader executing the order does so in line with the volume on the market. It is sometimes argued that such execution reduces transaction costs by minimizing market impact costs. The market impact cost is defined as the adverse effect of the trader’s activity on the price of a security.
Additionally, VWAP is often used in algorithmic trading. A broker may guarantee the execution of an order at the VWAP and have a computer program enter the orders into the market in order to earn the trader’s commission and create P&L. This is called a guaranteed VWAP execution. The broker can also trade in a best-effort way and answer the client with the realized price. This is called a VWAP target execution; it incurs more dispersion in the answered price compared to the VWAP price for the client but a lower received/paid commission. Trading algorithms that use it as a target belong to a class of algorithms known as volume participation algorithms.
The first execution based on the VWAP was in 1984 for the Ford Motor Company by James Elkins, the then head trader at Abel Noser.
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