As you’re well aware, technical analysis tools are abundant and come in all shapes and sizes.

I, for one, am a big fan of Fibonaccis and Moving Averages – they make sense for my strategies. In addition, they would often serve as additional reference points in my decision-making process.

At the same time, I know the limitations of TA – most indicators are lagging and will only give you information about something that’s already happened.

Well, today, I’d like to tell you something you likely didn’t know about VWAP – a technical tool that often gets overlooked yet may carry some accurate insight on the market’s behavior. 

What is VWAP?

VWAP stands for Volume Weighted Average Price and it means what it reads – the stock’s price averaged across every transaction in a period. 

Its goal is to smooth out price deviations and show what the average trade price is. 

You can arrive at it using the following formula:

VWAP = Sum(Volume * Price) / Total Volume

VWAP is a popular indicator and it’s freely available on virtually any trading platform. 

On a chart it looks like this:

NVDA chart with the VWAP line

There are a couple “traditional” uses for it: get a sense of a stocks trend; understand whether buyers or sellers are in control. 

Institutions use VWAP!

That’s right. 

Unlike many other technical analysis tools that traders may be skeptical about – VWAP is genuinely used by some of the biggest firms out there. 

Hedge fund managers utilize VWAP for various tasks, the biggest one being to judge the efficiency of their execution teams.

How so?

See, if you are a hedge fund manager, your portfolio spans eight, nine, ten or eleven figures and your positions run in millions of shares – every tick starts to make a difference.

Say you’d like to buy 500k shares of AAPL on a given day:

With VWAP being ~$133.8 a buy 20c higher puts a manager $100k short!

On the other hand, a 500k share sell order filled 40c lower eats away $200k from a fund’s bottom line.

Given the regularity and the magnitude of these transactions – execution quality becomes quite important!

The job of execution teams I mentioned above is quite literally to execute a manager’s large buy or sell order at the best price possible.  

VWAP, the average execution price for that day, becomes the most specific benchmark of their performance.

Active managers aside, VWAP may also be used by indices and other passive funds – those, whose main purpose is to average out returns and smooth out any outlier moves.

How You Can Gain Insights

So, now that you know that VWAP is utilized by the biggest market participants out there, the question becomes – how do you use this information to improve your skills?

As you can imagine, if a trader’s goal is to execute at a price closest to VWAP – a lot of his or her activity would be centered around it.

Obviously, a stock’s price still has outside supply and demand – it’s not going to simply hover right around VWAP.

That’s why institutions often rely on a range of 2 standard deviations away from VWAP in both directions. 

Luckily for us, most modern trading platforms will output that by default.

Let’s now have another look at the AAPL and NVDA charts I mentioned earlier:

NVDA

AAPL

Do you see any similarities or patterns? I think these charts speak for themselves.

There are obvious areas of support and resistance right above and below VWAP and 2 standard deviations away from it. 

While I don’t suggest you build your entire trade thesis around this – VWAP might be the only indicator that gives you “real” knowledge of what other market participants are doing.

And what price behavior you can expect at certain chart points.