How is VWAP calculated?

by | Corporate Finance |

When equity brokers pitch their share repurchase capabilities to corporations, they never fail to mention their ability to outperform VWAP. When asked how they outperform so consistently, the answers tend to be non-answers: “we have proprietary algorithms” “our traders are top notch” “we can see the flow“. They forget to mention that in many cases the client provides instructions that by definition outperform VWAP.
I’ll say it again:
“The client provides instructions that by definition outperform VWAP”
Enough said for the moment. Topic for another day.
But what’s VWAP and how is it calculated?
 

What is VWAP?

VWAP stands for Volume Weighted Average Price and its name is its definition: the average price of a stock over a specific period of time weighted by its trading volume.
The specific period of time is normally a 1-day period or shorter. (side note: I’ve seen multi-day VWAPs in pitchbooks but I suspect the bankers chose VWAP over a simple average just to sound sophisticated!).
Given its intraday nature, VWAP is a helpful benchmark to measure trading performance.
 

How is VWAP calculated?

We can calculate VWAP by obtaining tick data and volume per tick. A tick in this case is the change in price of a stock from trade to trade.
Here is an example with hypothetical trading data for GOOG.

 

Each row represents a trade. It includes timestamp, trade price, and volume (number of shares traded). As you can see in the calculations region, calculating VWAP requires a few simple steps:

  1. aggregate Volume Per Trade
  2. for each trade, multiply Price x Volume
  3. aggregate Price x Volume
  4. divide 3) by 1)

A new VWAP is calculated after each trade is completed. If you pay attention, VWAP is a form of moving average. It lags current price because it is calculated based on past data.

Note on data collection

I used 3-second intervals for illustrative purposes. In reality, there could be several trades executed in a 3-second interval. With 390 minutes in a normal trading day, the amount of data necessary to calculate VWAP can be massive. For this reason, many times VWAP is available based on fixed intervals: 1, 5, 10, 15 minutes or more.

Do I care about VWAP?

If you’re running a stock repurchase program, I’d say yes. Your performance vs. VWAP is something to keep an eye on, but I wouldn’t lose sleep about unless you find yourself consistently underperforming. If this is the case, there’s probably a structural flaw in your instruction set.

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