TWAP vs VWAP in Crypto Trading
Crypto Basics

TWAP vs VWAP in Crypto Trading

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Crypto trading can be confusing but learning the difference between TWAP and VWAP doesn't have to be — let us help you decipher these trading indicators!

TWAP vs VWAP in Crypto Trading

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If you judge TWAP (time-weighted average price) and VWAP (volume-weighted average price) based on their names, they may seem too similar - or maybe the same. However, these two indicators offer different values to traders. Let’s find out what they are, how they compare, and how you can use them in crypto trading.

What Is the Volume-Weighted Average Price (VWAP)  in Crypto?

The volume-weighted average price is a popular indicator primarily used by intra-day traders. The tool has a similar function as (exponential) moving averages, displaying the overall direction of a market – but works quite differently.

Where moving averages simply calculate the average price per candle, VWAP takes into account the transaction volume per candlestick relative to the total volume traded in a day.

How Is Volume-Weighted Average Price (VWAP) Calculated?

Step 1 – Calculating the Typical Price

For each candlestick, add the high, low and closing values of the candle, and divide the final value by three. The outcome of this calculation has many names - but for the sake of simplicity, we will call it the typical price.

Step 2 – Multiplying by Volume

Multiply the typical price by the total transaction volume in a candlestick. This gives you volume-adjusted data - let’s call it VAD. Do this calculation for every candlestick in the trading session.

Step 3 – Calculating VWAP

Now, the volume-adjusted data value will result in inflated numbers, much higher than the average price. In order to bring it back to reasonable levels, we have to divide the sum of all VAD by the total transaction volume.

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Formula to Calculate Volume-Weighted Average Price (VWAP)

When looking at the above steps, we can produce the following formula for calculating VWAP, Where ∑ indicates the sum of all the values derived from each separate candlestick:

{∑(Typical Price * Transaction Volume)} / Total Transaction Volume

This calculation results in the volume-weighted average price, an indicator many traders find highly useful. After all, volume is considered one of the most important metrics in trading – and this moving-average-akin tool incorporates it.

How To Use Volume-Weighted Average Price (VWAP) in Your Trading?

Some traders use the VWAP as a trend-following tool, while others look to it to determine overbought and oversold conditions: only buying assets that trade below the VWAP and selling assets above the VWAP – a kind of mean reversion trade.

Another common strategy goes exactly opposite to that approach; where traders view a cross above the VWAP as a bullish sign and a cross below it is viewed as a weakness.

Is Volume-Weighted Average Price (VWAP) a Lagging Indicator?

As discussed earlier, VWAPs are mostly used on intraday charts. This is because the indicator gets laggier as more and more data is added to the calculation. At the end of a trading session, the VWAP may behave similarly to a slow-moving average. Nevertheless, traders have found ways to use the VWAP across all time frames - all the way up to yearly charts.

What Is the Time-Weighted Average Price (TWAP) in Crypto?

A time-weighted average price indicator works similarly to its volume-weighted brother, displaying the overall direction of the market. TWAP is calculated by deriving the typical price for each candle and then calculating the average.

How Is Time-Weighted Average Price (TWAP) Calculated?

The TWAP is calculated using the same typical price calculation as used in the VWAP calculation. In this case, we compute an average using solely the typical price, without adjusting for transaction volume.

Formula to Calculate TWAP

Based on the above, the following formula can be derived:

TWAP = (∑Typical Price) / Number of candles

What Is a TWAP Order?

However, in most cases, the term TWAP is used to refer to a TWAP strategy – an advanced execution strategy and order type most commonly used to fill larger positions with limited liquidity, without slippage or unnecessary volatility. The TWAP order is an algorithmic trade execution tool that allows traders to execute a large buy order in smaller batches at regular intervals. As a result, traders can fill positions with an average execution close to the time-weighted average price over a specific time period.

Example of TWAP Orders

For example, Suzie might use a TWAP order to buy 0.10 BTC every ten minutes, buying a full Bitcoin over the course of 100 minutes.

What Are the Benefits of TWAP-Based Trading?

Avoid Causing Asset Volatility

TWAP orders are commonly used by larger players, such as MicroStrategy. They have accumulated over 138,000 Bitcoins over the past years - a number that would have caused significant volatility if they were bought at once on the open market. Orders of that size can be executed smoothly using TWAP orders due to the division into smaller chunks.

Hiding Your Intent From Other Large Traders

Another reason to use TWAP orders is to hide your intent from other large traders. Larger market orders leave a footprint in the books, which allows your competition to follow your moves. By using TWAP orders, competition will struggle to keep track of what you are doing, allowing you to move in silence.

Suitable for Frequent Day Trading

Certain traders use them for high-frequency trading – deploying TWAP orders at relevant areas of interest while keeping the trading strategy simple.

Suitable for Algorithmic Trading

TWAP orders are perfectly suited for algorithmic trading. When combining TWAP orders with algorithms, traders can automatically derive the optimal time to execute an order and let the algorithms execute these trades without much human interference.

Simplicity

TWAP is a relatively simple concept that even beginner traders can understand and apply.

Risk Management

Because TWAP orders allow traders to get average entries that are close to the time-weighted average price, the order type can help reduce the risk of a trade.

What Are the Limitations of TWAP-Based Trading?

Its Simplicity Can Betray the Intent

The simplicity of TWAP comes with a drawback. While large players may use it to cover their tracks, the method is so simple that it doesn't take a genius to see what is happening. If the competition spots a series of equally-sized orders in a short period of time, they'll soon figure out what you're doing.

Limited Usefulness for Small-Scale Traders

Because TWAP orders break a large order into smaller pieces, the order type is not very useful for traders with smaller accounts. In some cases, the order type might not be available at all. Binance, for example, limits the use of TWAP orders to a minimum of $10,000.

VWAP vs TWAP: Key Differences and Similarities Explained

While time-weighted and volume-weighted average price suggests that the two are very similar indicators – the reality is a little bit different.

Time-weighted average price (or TWAP) is an order type commonly used to fill large orders incrementally, minimizing market impact.

The volume-weighted average price or VWAP is an indicator similar to the moving average that displays the overall direction - but takes into account the transaction volume in its calculation.

Closing Thoughts

All in all, the VWAP and TWAP are two great tools to add to your toolbox. Even though they have similar names, TWAP is most often used to describe the TWAP order type, a trading strategy used by large players to fill their orders.

No matter how powerful technical analysis tools might be, it is important not to use them in isolation. Indicators, such as the TWAP and VWAP, work most effectively when used in confluence with other analyses and tools. For example, while traders might look to buy an asset that trades below the VWAP, considering it an oversold asset – a strong downtrend can keep the asset prices below for much longer than expected.

Writer’s Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form. Please do your own research.

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