The Volume-Weighted Average Price (VWAP) is a trading algorithm designed to execute large orders according to a predetermined schedule, aiming to minimize the effect on market prices.

For instance, if you intend to purchase 15 million shares of Apple (or 1000 BTC), which represents nearly half of its average daily trading volume, executing the entire order at once would likely disrupt the market and drive the price up.

To avoid this, you should divide the order into smaller segments and execute them gradually to prevent market impact. Managing this process manually would be impractical, which is where an execution algorithm like VWAP becomes essential.

VWAP is also regarded as an indicator of the average price at which an asset is traded over a specific timeframe. The formula for calculating VWAP is:

VWAP = ∑(amount of asset bought x asset price) / total shares bought that day.

The standard VWAP is computed using all orders from a particular trading day, but it can also be analyzed across various time frames. The VWAP ratio is typically displayed on a chart as a line.

It is often compared to a moving average; when the price is above the VWAP line, the market is perceived to be in an uptrend, while a price below the VWAP indicates a downtrend.

Many large institutions utilize the intraday VWAP as a benchmark for fair value, guiding their accumulation or distribution strategies. This means that if the price is below the VWAP and they have an urgent need to purchase a significant number of shares within a specific timeframe, they will aim to buy at prices lower than the VWAP.

However, if they fall behind in their accumulation efforts, they may begin purchasing slightly above the VWAP to signal their intentions. If multiple institutions adopt this approach, they may end up competing for the same VWAP bid.

Many day traders are aware of this behavior and often engage in bullish momentum trades when the price diverges above the VWAP, or bearish trades when it diverges below the VWAP.