In VWAP strategy, traders first define the average value of security prices weighted by trading volume over a period of time.
The purpose of the VWAP algorithmic trading strategy is to split the order as much as possible. According to VWAP, split orders need to be submitted in proportion to the actual market trading volume, which requires a forecast of the market’s intraday trading volume.
In the VWAP strategy, the traders use the weighted average of the segmented trading volumes of the past M trading days as the predicted trading volume, which involves the determination of M and the weight.
Assuming that a certain number of stocks need to be purchased within a certain period of time, algorithmic trading is used to divide this period of time into N parts.
The trading ratio of each part of time (accounting for the required trading volume) is predicted to be vp, and the actual market segment transaction ratio (accounting for the actual market transaction volume) is vm. The actual transaction price of the market at each point in time is P, and then the tracking error can be defined as:
From the definition of TE, we can see two points:
- Tracking error is closely related to volume forecasting, and the quality of forecasting directly affects the results of VWAP algorithm trading.
- When a certain period of time vp exceeds the market reality vm, it is possible that all orders cannot be executed, which will result in a decrease in the efficiency of algorithmic trading execution. Therefore, the more commonly used strategy is the so-called “feedback” VWAP algorithmic trading strategy.
The so-called VWAP algorithmic trading strategy with feedback means that on the basis of the original VWAP tracking, the unexecuted orders in each period are proportionally allocated to the subsequent time periods, which can effectively improve the transaction ratio.
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