VWAP & TWAP – Execution Algorithms
Institutional traders (Mutual Funds, Hedge Funds) cannot just click "Buy". Their orders are too big. They use Execution Algorithms to split their orders intelligently. The two most common benchmarks are VWAP and TWAP.
1. VWAP (Volume Weighted Average Price)
"Buy along with the crowd."
- Logic: VWAP executes more volume when the market volume is high, and less when it is low.
- Profile: It mimics the market's "Volume Smile" (High volume at Open/Close, Low at Lunch).
- Goal: To achieve an execution price close to the day's average price weighted by volume.
- Usage: The gold standard for institutional execution. "Did you beat VWAP?" is the most common performance metric.
Formula
VWAP = Sum(Price_i * Volume_i) / Sum(Volume_i)
2. TWAP (Time Weighted Average Price)
"Buy evenly over time."
- Logic: Slices the order into equal chunks and executes them at regular time intervals (e.g., Buy 1000 shares every 5 minutes).
- Profile: Linear / Flat execution.
- Usage: Used when volume data is unreliable or for very illiquid stocks where you just want to drip-feed the order.
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Note
Gaming the Algo: Intelligent HFTs try to "sniff out" VWAP/TWAP orders. If they detect a TWAP algo buying every 5 mins, they will Front Run it (Buy just before the 5th minute and sell it to the algo at a higher price).
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