# Understanding Volume Weighted Average Price (VWAP) and How to Use It

VWAP is an intra-day calculation used primarily by algorithms and institutional traders to assess where a stock is trading relative to its volume weighted average for the day. Day traders also use VWAP for assessing market direction and filtering trade signals. Before using VWAP, understand how it is calculated, how to interpret it and use it, as well the drawbacks of the indicator.

## Calculating VWAP

To understand VWAP, let’s look at its inner workings. VWAP overlays the price data, and shows the average price of the day, weighted for volume.

Institutions often base VWAP on every single tick of data that occurs during the trading day. Calculating VWAP based on other time frames, such as 1-minute or 5-minute price bars is also acceptable, and is how most chart platforms such as FreeStockCharts.com or StockCharts.com compute the indicator.

Calculate VWAP using the following steps:

• Pick what period you’ll use as your input, 1-minute price bars, 5-minute price bars, etc.
• For each bar take the High + Low + Close and divide by 3. This gives you a “typical” price for that period.
• Multiply the typical price of that period by the volume for that period, to get the Weighted Price.
• Keep a running total of the Weighted Price, as well as a running total of volume as new data becomes available (a period ends). These are called Cumulative (or Total) Weighted Price and Cumulative Volume respectively.
• To get the VWAP, divide the Cumulative Weighted Price by Cumulative Volume.

Be sure to also read our Ultimate Guide to Analyzing Trading Volume.

## VWAP Uses and Strategies

VWAP starts at the open price, and then moves up or down based on price movement and volume.

VWAP eliminates much of the noise seen in a stock throughout the day, even more so than a moving average would. At the start of the day the VWAP is more sensitive to price moves, but as the day progresses it becomes less so. This is because it’s based on cumulative values, so as these values get larger toward the end of the day, each new piece of data has less and less effect on the VWAP.

All charts courtesy of FreeStockCharts.com

When the price is below the plotted VWAP values the trend is likely down, or there is a downward bias to the trading day. Institutions looking to buy will often try to buy when the price is below VWAP, as they are able to accumulate a position at a better than typical (VWAP) price.

Short-term traders usually do the opposite, interpreting the price below the VWAP as bearish, and looking for short positions.

When the price is above the plotted VWAP, the trend is likely up, or there is an upward bias to the trading day. Institutions looking to sell or short will often try to sell when the price is above VWAP, as they are able to accumulate a short position or dump shares at a better price than what has been typical so far in the day (VWAP). Short-term traders usually do the opposite, interpreting the price above the VWAP as bullish, and look for long positions.

VWAP is a guide and a source of price information that reduces market noise. It does not provide entry signals, stop loss levels or target prices.

Figure 2 shows how an institution looking to accumulate a position (buy) or dispose of a position (sell or short) would view its transactions relative to VWAP.

Figure 3 shows how retail traders use VWAP in helping them decide whether they should be focused on finding long or short trade opportunities as the day progresses.