Vwap

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Question one:

The volume weighted average price has several shortcomings associated with it. These are:

Impact cost

VWAP does not identify the impact of a day’s selling activity. A stock’s fall is often realized later on.

Measurement

Since VWAP does not measure impact, when liquidity is a factor, it is rendered ineffective with less liquid orders (Hautsch, 2012)

Manipulation

With large orders or low liquidity socks, traders can manipulate the VWAP price to make their execution look better since the prices change throughout the day.

Opportunity cost

The average purchase price is increased when a buy order is purchased, in line with marked volume, as the price escalates (Hendershott, 2013)

Emphasis on volume

In VWAP, volume is more important than price to the traders. The market impact and direction don’t matter as long as they are participating.

Question two:

VWAP is a useful tool for short term trading and therefore is employed by many traders, so improving its execution quality would be highly advantageous.

Cutting down on the amount of historical data needed to calculate the VWAP is bound to give values closest to the actual values. The calculations being done at specific times like at the beginning and at the end would ensure that the values collected would be accurate. For example, at six o’clock in the morning, and at six in the evening would ensure that data collected would have small error margins.

A day’s selling activity being monitored would reduce risks involved, noticing any falls in the stock. Traders being educated on the importance of price and volume at a go would hinder there being insecurities.

References

Hautsch, N. and Ruihong, H. (2012). The market impact of a limit order. Journal of Economic Dynamics and Control, 36, 501-522

Hendershott, T., C.Jones, and A.J. Menkveld. (2013), Implementation Shortfall with Transitory

Price Effects, in High Frequency Trading; New Realities for Trades, Markets and

Regulators, Easley, D., M. Lopez de Prado, and M. O’Hara (editors), Risk Books (London: 2013).