Wednesday, December 29, 2010

Volume weighted average price VWAP

When I started trading I followed all kinds of people online, in chat rooms, net forums, blogs, sites. One of the most consistent, with regards to message, was Brian Shannon of alphatrends. He first had a blog, alphatrends.blogspot if you are going to search for it. He explained things, shared some insight, provided some big market perspective. He talks about VWAP in the following manner at this link VWAP alphatrends

"Consider a market maker with a day order to buy 1 million shares of a stock for an institutional customer. The market maker cannot just go in and buy the full position in the first two hours of the day and then leave his desk to go play golf. Market makers are evaluated by their customers for the quality of trade execution; did they get a fair price for the customer? The most common method of used to analyze the quality of a trade execution is to compare the price the order was filled to the Volume Weighted Average Price (VWAP). The VWAP is calculated by dividing the dollar volume of a stock by the share volume over a given period of time. Simply put, the VWAP is the average price that each share was executed over the period of time being studied. There are several ways to calculate the VWAP in RealTick, the analysis and trading software I use. I prefer VWAP analysis with a moving average, in particular for shorter term day trades on a one day chart of the equity I am trading.

The VWAP is considered to be a fair benchmark for comparison of the institutional trade desks ability to execute trades on behalf of the customer. If the brokerage purchases were made at a price less than VWAP then they did a good job for the customer. If the price paid was greater than the VWAP they may lose that customer for future transactional business. The daily VWAP is a number which changes as orders are transacted at varying prices throughout the day. "

So the way I try and think of things is how I stack up against the competition be it you, Fidelity, the market makers, etc... While I do not aim to beat the VWAP, it can be used for timing of entry and exits. One such explanation again comes from the old alphatrends: VWAP strategy

Here is how I thought of a stock and VWAP today. If you click on the chart you will see larger version of VMWare chart. I have followed this stock for a while. Price went down at the open, kind of double bottomed around 1140, came back above VWAP, and is now right about there. Given the quiet market, lack of strong recent trend in the stock, don't you think it will close around the VWAP for the day? Knowing this, oculdn't it have been bought around the double bottom point, sold once above VWAP, perhaps even shorted it above the VWAP?

IMO, VWAP can be used with success for daytrading in this manner and for timing of entry and exits for trend traders and investors.

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