Introduction

Suppose you embark on a journey into algorithmic trading in the Indian stock market. In that case, you will undoubtedly find that learning execution strategies like VWAP (Volume Weighted Average Price) and TWAP (Time Weighted Average Price) will increase your trading efficiency tremendously. VWAP is a method institutional and retail traders use to have minimal effect on price when executing large parcels of trades. Whether you are trading the Nifty 50 stocks or a mid-cap stock with lower liquidity, understanding the difference between TWAP and VWAP is key to better execution. Let's look at how these strategies work and when to deploy each.

What Is VWAP?

The complete form of VWAP is Volume Weighted Average Price, and the name says it all.  VWAP is the average security price, based on the prices at which that security was traded during a trading session, weighted according to the volume at which those trades occurred. The VWAP formula is simple: VWAP = ∑(Price * Volume) / ∑Volume—where the price is typically the average of the high, low, and close at each price interval. Using VWAP as an execution strategy means executing trades at prices around the VWAP of a particular asset. VWAP helps reduce market impact by aligning trades with high-volume periods, aiming for better average execution.

Buying below VWAP and selling above VWAP helps indicate that you get better execution than the average market. If, for example, we are looking at something liquid like the constituents of the Nifty 50, VWAP helps you execute large orders without moving too far from the price when it adjusts back to high traded volume.

What is TWAP?

The Time Weighted Average Price (TWAP) focuses on spreading your trades evenly over a set period, regardless of volume. The TWAP formula is simpler: TWAP = ∑(Price at each interval) / Number of intervals, using the last traded price at fixed time points. This makes TWAP great for orders being executed systematically and sequentially, especially in illiquid markets where large trades may cause a price disruption.

Let's say you want to buy 20,000 shares of a mid-cap stock over 4 hours. If you used TWAP in this instance, you could execute 48 evenly spaced executable trades of 417 shares over 5-minute increments. The systematic approach mitigates your market footprint and makes it difficult for your trading pattern to be predicted, which is essential in illiquid Indian stocks.

There are important differences between VWAP and TWAP

When comparing TWAP vs VWAP, the most apparent difference is the approach:

• VWAP places relatively more emphasis on volume and will execute more shares when the trading is busy. TWAP disregards volume and is only focused on time intervals.

• Market Impact VWAP is agile during market conditions and intended for liquid stocks (Reliance Industries). TWAP enforces a schedule and uses it during those time intervals to help minimise price distortions in illiquid assets.

• Complexity VWAP requires modifications to account for volume; TWAP is less complex because it uses a straightforward time-based trading algorithm.

• VWAP is used for high-volume markets where an average price is anticipated. TWAP appears in stealth fashion when used in volatile or low-liquidity equities.

When to use VWAP?

Volume-weighted average price (VWAP) trading is highly effective for execution in liquid markets. If you're trading Nifty 50 stocks or ETFs that track it, VWAP helps align execution with market volume. VWAP can also effectively benchmark your activity against the market average, so trades do not excessively impact the price. For example, executing large orders throughout the day, driven by trade execution plans with institutional traders, matched with larger orders, drives the market trend.

When to Use TWAP?

Use TWAP if you are trading in illiquid stocks or want to mask the fact that you are selling. TWAP will likely mitigate price spikes due to low liquidity in Indian mid-cap or small-cap stocks. TWAP executes evenly across time intervals, regardless of trading volume. It is also helpful during volatile periods of the market, like post-earnings announcements, when you may influence volume spikes that can completely offset the VWAP executions you may be depending on.

Conclusion

As a trader, you should choose TWAP and VWAP based on your objectives and the liquidity of the assets you want to trade. Generally, you will approximate the market averages if you trade volume-weighted average price in liquid stocks. If you trade the time-weighted average price, you will achieve stealthy execution in less liquid markets. You can also pair these strategies with the following additional technical indicators to get a better foundational understanding of the market beforehand, such as moving averages or support levels. Overall, possessing knowledge of TWAP vs VWAP can assist you in executing trades smartly, so that you can minimise your costs and maximise your returns in the Indian markets.

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