VWAP

A volume weighted average price (VWAP) is used as the published closing price of a security.

The obvious closing price is the last price at which a security traded before trading stopped for the day. The problem with this is that a small transaction at the end of the day can change the closing price. This means that the closing price can reflect freakish trades (e.g., one resulting from the accidental entry of a buy at a very high price of a sell at a very low price). Even worse, it can open the way to deliberate distortion of the price through the placing of orders at very high or low prices just before trading closes.

Using VWAP solves this problem. It the average price at which a security traded over a period prior to the close of trading. The period runs for a fixed time ending with either the close of trading or at the time of the last trade in the security. The exact method used to calculated a VWAP will depend on the trading rules of the market in question.

The VWAP is the value of trading in the period, divided by the number of shares traded in the period.

Of course the VWAP does not solve the problem completely for very illiquid securities, whose prices remain easily manipulated, but it does make it much harder to manipulate closing prices for a wide range of moderately liquid securities.

There are a number of motives for manipulating closing prices. Closing prices of underlying securities are used to calculate the settlement values of derivatives. Closing prices are also used for formal statements of the value of a portfolio (e.g., in a company's annual report). They are sometimes used to calculate directors' remuneration. They will have an impact on an index and therefore on the prices of index derivatives.

An alternative way in which markets can provide a hard to manipulate closing price is through holding a closing call auction. This has the disadvantage of requiring the use of a particular trading mechanism, whereas VWAP requires only an extra (automated) calculation.

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