Using VWAP to Measure Transaction Costs

Volume-weighted average price (VWAP) is the average price at which a stock trades in a given period, weighted by the volume traded at each price. Many investors use the difference between their own execution price and the VWAP as a measure of their execution costs (specifically the market impact.)

The advantages of using VWAP to measure trading costs are that it:

  • is easy to compute
  • is easy to understand
  • can be computed quickly, which helps traders make execution decisions in real time
  • works best when measuring relatively small trades in markets without a strong trend

Disadvantages of VWAP include:

  • the fact that it doesn’t account for costs related to delays or trade cancellation (implicit costs such as the stock “getting away”)
  • it can be misleading if the trader’s volume is a significant percentage of the total volume
  • it is not sensitive to the prevailing market conditions or the size of the trade, which both impact execution
  • it can be gamed by delaying trades whenever the market price is above the current VWAP
For more information, see all articles on: Active Management, Investing in Stocks, Portfolio Management, Risk Management, Trading Execution

See also:
  • Volume Weighted Average Price (VWAP)
  • Execution or Transaction Costs
  • Algorithmic Trading Methods
  • Implementation Shortfall
  • Crossing Trades Externally
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    The Intelligent Investor: The Classic Text on Value Investing

    Financial Statement Analysis: A Practitioner's Guide, 3rd Edition

    Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)

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