Why is volume-weighted average price (VWAP) important?
The volume-weighted average price (VWAP) helps provide insight into a security's pricing trend and value. Combining price with volume can provide a truer average price for a stock. That makes it a better gauge of its value than the closing price, which might be skewed by a lack of volume.
Many stock traders use VWAP to determine intraday pricing trends to decide when to buy or sell a security. Institutional investors will also use VWAP when making a high-volume trade. They'll aim to buy or sell a security near its VWAP to move a heavy volume in a series of trades without having a big impact on the stock price since it aligns with demand.
VWAP is also an important metric used in corporate transactions because it shows an unaffected price over a period of trading days. For example, companies will also use VWAP when completing an accelerated share repurchase (ASR) program. In addition, when noting a premium offered on an acquisition, an acquiring entity will often cite the VWAP of their target's stock price over the past 20 or 30 trading days. Finally, other corporate transactions will use VWAP to determine the trigger price of an earnout provision, which is common in a merger agreement with a special purpose acquisition company (SPAC).
How to use volume-weighted average price (VWAP)
VWAP is typically used to determine the demand for a security. Short-term stock traders will use a stock's VWAP trend to see if money is moving into or out of a security. If the stock's current price doesn't reflect its VWAP, that could indicate an opportunity for a trade.
VWAP can also be a helpful metric for investors with a long-term mindset because of its importance in corporate transactions. For example, it helps companies more accurately reflect the premium they're offering on an acquisition compared to its recent trading price, which might have moved based on rumors or speculation that a deal was forthcoming.
It can also help prevent any manipulation of a stock-based earnout. By basing the earnout or warrant redemption on a stock's VWAP, it ensures that a security has genuinely reached the specified price to trigger the action.
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