Quick definition VWAP is the average price of all trades executed throughout the day, weighted by volume. It serves as a benchmark for execution performance, especially for large orders. What it is To calculate VWAP, sum the price of every trade multiplied by the volume of that trade, then divide by total volume. The result is a price that reflects the entire market's trading activity, weighted toward times and prices with high volume. Most institutional investors use VWAP as their execution benchmark. An execution algorithm that achieves a better average fill than VWAP has outperformed the market. Why it matters VWAP is a passive benchmark. It does not require predicting where the market will move. Instead, it assumes you will trade at the average price that the market traded at during the day. For traders with no informational edge, VWAP is a reasonable target. VWAP versus TWAP TWAP (Time-Weighted Average Price) divides the day into equal time intervals and trades equal amounts in each interval. VWAP divides the day according to expected volume, trading more during high-volume periods and less during low-volume periods. VWAP tends to result in better fills if volume is predictable but requires knowing in advance when high-volume periods will occur. Practical example You need to buy 1 million shares of a stock with 5 million shares of expected daily volume. If you execute in proportion to expected volume (20 percent of the expected volume in each quintile of the day), your average fill should be close to VWAP. If the stock has an unusual spike in volume at 2 PM (when earnings are announced), you buy more shares at that time. You hit higher prices but buy a larger percentage of your position at a time when the rest of the market is also buying, so you execute at a price close to the crowd average. Limitations VWAP assumes that volume is predictable. In markets with sudden spikes or drops in volume, VWAP algorithms can become ineffective. If you need to execute all your shares by a specific time (not by end of day), VWAP is not applicable. See also - TWAP (Time-Weighted Average Price) - Market Impact - Execution Algorithm - Benchmark
