What is a Volume-Weighted Average Price (VWAP)?

Volume Weighted Average Price (VWAP) is an important metric in the trading world that is used by day traders and institutional traders. With both price and volume data, it gives a better representation of the value of an asset over a period.

Understanding VWAP

VWAP stands for Volume-Weighted Average Price, which means that this tool helps traders understand the average price at which a security has changed hands throughout the day, based on both price and volume. 

It is an important indicator for intraday trading techniques which assist in deciding when to buy and sell.

How to Calculate VWAP

VWAP formula is simple but largely involves many steps as follows:

1. Calculate the Typical Price: The average of the close, high, and low prices for each trading session is the typical price.

Typical Price= (High+Low+Close)​3

2. Multiply by Volume: Multiply the typical price by the trading volume for that period.
3. Cumulative Totals: Sum the results of the typical price multiplied by volume for all periods and divide by the total volume traded during the same periods. 

VWAP= ∑(Typical Price×Volume)​​∑Volume​

This calculation determines the average price of the asset weighted by volume so you can get a better idea of where most of the trading activity took place for that day.

Importance of VWAP

Trading Strategy

VWAP is very commonly used as a benchmark by the traders. If the prevailing price is below VWAP, it could be that it is undervalued and a sign it may be a good time to buy. 

When the price is below the VWAP, it could signal an undervaluing, indicating a buying opportunity. On the contrary, when above the VWAP, one might view that asset as overvalued which could mean a sell​​.

Institutional Trading

VWAP serves as an important measure for bigger institutions which have to implement buy/sell orders that are big enough so they cause no movements of the market prices. 

This allows them to see the average price and make sure that they trade near to this causing as little distortions to market price as possible.

Day Trading

VWAP is a common tool used by day traders to help identify trends that can act as both entry and exit points. VWAP above the VWMA core represents bullish, VWAP lower than the falling VWMA core indicates bearish. 

In such cases, traders can buy on price breaking above the VWAP and sell on a move under its level, representing a trading range using VWAP as dynamic support and resistance.

Advantages of Using VWAP

1. Enhanced Price Accuracy: VWAP aggregates price and volume information to more accurately reflect the true average price of an asset.
2. Trend Confirmation: VWAP can give our traders an extra level of information to act upon by assisting in the confirmation of whether or not a trend is stronger and increasing the probability that it is set to continue in a new direction.
3. Liquidity Insight: VWAP shows where liquidity zones exist and thus provides traders with favourable points to enter and exit trades.

Limitations of VWAP

Despite its usefulness, VWAP has certain limitations:

1. Intraday Use Only: VWAP is really only applicable to intraday usage and not as much beyond a couple of days.
2. Lagging Indicator: VWAP is lagging indicator data as it uses historical information to confirm the trend which has already happened instead of predicting future price moves.
3. Not Standalone: Remember, never to use the VWAP as a single trading method but rather in combination with other tools for better trades.

VWAP in Practice

To incorporate the VWAP into your trading strategy, use it in combination with:

• Combine with Other Indicators: VWAP trading strategies are best used in combination with other technical indicators like moving averages, RSI, or MACD to give a full picture of market conditions.
• Monitor Throughout the Day: Watch VWAP all time during the trading day and adjust your strategy in accordance with impending price movement over/under the line.
• Volume Consideration: VWAP should always be interpreted in context with volume. Greater volumes around the VWAP points indicate a substantial support or resistance.

Conclusion

VWAP is important for traders and investors as it gives a fair value of the price of an asset which includes the volume data. This benefits traders by keeping them better informed, supporting improved trade execution for large orders and confirming trends for day trading strategies. 

But, in practice, you should use it with a more comprehensive trading style knowing its limitations and using additional indicators to be successfully traded.