In finance, volume-weighted average price (VWAP) is the ratio of the value traded to total volume traded over a particular time
horizon (usually one day). It is a measure of the average price at which a stock is traded over the trading horizon.
VWAP 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 volume on the market. It is sometimes argued that such execution reduces transaction costs by minimizing market impact
costs (the additional cost due to the market impact, i.e. the adverse effect of a trader's activities on the price of a security).
VWAP can be measured between any two points in time but is displayed as the one corresponding to elapsed time during the trading day by the
VWAP is often used in algorithmic trading. Indeed, a broker may guarantee 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. This is called a guaranteed VWAP execution. The broker
can also trade in a best effort way and answer to the client 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 VWAP as a target belong to a class of algorithms known as volume participation algorithms.
The first execution of the VWAP was in 1984 for the Ford Motor Company by James Elkins, then head trader at Abel Noser.
Using the VWAP
The VWAP can be used similar to moving averages, where prices above the VWAP reflect a bullish sentiment and prices below the VWAP reflect
a bearish sentiment. Traders may initiate short positions as a stock price moves below VWAP for a given time period or initiate long
position as the price moves above VWAP.
Institutional buyers and algorithms will often use VWAP to plan entries and initiate larger positions without disturbing the stock price.