Undervalued or Overvalued? - Volume-Weighted Average Price
Volume-Weighted Average Price (VWAP) is showing day average price based on done transactions.
Using Volume value as weight is crucial here. I will try to explain it on the example.
We can calculate average price from D1 bar (even on few ways: [open + close]/2 , [high + low]/2, [high + low + close]/3). It’s simple but inaccurate. Imagine now high candle on the chart and 2 cases:
1. First where most (99%) of trades that day were done on the low price
2. Second where most of trades that day were done on the high price
Our simple average would have the same value in both cases, but market situation is quite different for each of them. VWAP is better by including transaction volume. In the 1st case VWAP would have value around low price and in the 2nd case around high price. A much precise information about other traders and their transactions.
I hope that now you can see how VWAP is better than simple average price.
How we can use VWAP?
1. VWAP is quite popular tool for assessing transactions in the short term. Prices below VWAP are considered as undervalued and prices about VWAP are considered overvalued. This knowledge may be useful with intraday trading, to get information where on the market we are and how valuable are our positions in comparison with other trades done in that time.
2. VWAP can be used to assess the quality of the execution of large orders. Whale (a huge player), when ordering his broker to sell a large number of shares, expects the average execution price of his order to be above the average price for that day. Broker is knowing that and will be trying to achieve that goal even with some price manipulation.
3. We can also use VWAP to hide our transaction. I mean sell or buy without affecting price and showing intensions on the price chart. Knowing the VWAP we can buy below it or sell over it. That way our action will be keeping price with the average transactions, minimizing the impact on the price chart. If trade is big enough it will leave a trace in the volume, but most investors probably will not notice it. The topic of volume as a reliable indicator of the presence of large players will be discussed in the next post.
Where can we find VWAP?
Probably each trading platform has VWAP implementation. I can recommend Trading View with Chart+ product. If you do not know the platform please read my previous post, about TradingView.
Starting from TraidingView Chart+ page, you should open Indicators dialog. It’s available under “Indicators” button at the top panel above the chart. VWAP can be found under the name: “VWAP – Volume-Weighted Average Price”. This is my own, completely free implementation.
On YouTube I’ve prepared VWAP script description with settings details:
I hope that this material was useful and has shown you the role of volume in better understanding current price value. If you like my work, please “Boost” all the scripts.
In the next posts, I will try to focus on using the volume.