TWAP and VWAP Strategies Minimize Market Impact in Crypto Trading

Algorithmic trading has become a popular method for many traders, allowing them to automate trades based on specific rules without the influence of emotions or hesitation. These strategies can continuously scan markets, react instantly to price movements, and handle large volumes more efficiently than human traders. Common algo trading strategies include trend following, arbitrage, market making, and mean reversion.

Within the realm of algorithmic trading, execution algorithms play a crucial role. Unlike strategies that predict market movements, execution algorithms focus on entering or exiting positions without significantly impacting the market. These algorithms are particularly useful for handling large orders discreetly. A key subset of these algorithms is passive order execution strategies, which aim to minimize slippage and achieve a fair average price. The two primary strategies in this category are Time-Weighted Average Price (TWAP) and Volume-Weighted Average Price (VWAP).

TWAP, or time-weighted average price, is a straightforward and widely used execution strategy in algorithmic crypto trading. It involves breaking down a large order into smaller trades executed evenly over a set period, regardless of market volume. This strategy is particularly useful for executing large trades quietly and in low-liquidity environments, where even moderate orders can move prices. By pacing trades, TWAP helps reduce slippage and keeps trading activity under the radar. However, its simplicity means it does not account for trading volume, which can be a drawback during high-volatility periods or sudden market shifts.

VWAP, or volume-weighted average price, is another important metric for traders seeking a more accurate sense of an asset’s average price throughout the day. Unlike TWAP, VWAP factors in the volume traded at each price, giving more weight to prices with higher trading activity. This makes VWAP a better reflection of the market’s true value. Traders often use VWAP as a benchmark to determine if they are getting a better-than-average deal compared to the rest of the market. It is also useful for spotting trends, as a price above VWAP may indicate a bullish market, while a price below VWAP could signal a bearish trend. However, VWAP is more complex to calculate and can be skewed by unusually large trades.

To calculate TWAP, traders take the price of the asset at regular time intervals, sum them up, and divide by the number of intervals. For example, if a trader checks the price of Bitcoin every 10 minutes and gets the following prices: 90,000, 90,100, 89,900, and 90,050, the TWAP would be calculated as (90,000 + 90,100 + 89,900 + 90,050) / 4 = 90,012.5.

VWAP, on the other hand, involves multiplying each price by its corresponding volume, summing these values, and then dividing by the total volume. For instance, if a trader has the following data for Bitcoin: 90,000 at 10 trades, 90,100 at 20 trades, 89,900 at 5 trades, and 90,050 at 15 trades, the VWAP would be calculated as (900,000 + 1,802,000 + 449,500 + 1,350,750) / (10 + 20 + 5 + 15) = 90,045.

The choice between TWAP and VWAP depends on the trading scenario. VWAP is ideal for trading during busy hours when volume is high, as it provides a sense of the market’s true average price. TWAP, however, is better suited for quieter trading times or less liquid coins, as it helps traders move in and out of positions without alerting the market. In summary, VWAP is used for following market momentum and timing trades smartly, while TWAP is preferred for discreet and simple trading strategies.

In real-world examples, TWAP and VWAP have proven effective for minimizing market impact and securing better execution prices. For instance, Strategy, a company, used a TWAP strategy to execute a $250-million Bitcoin buy in August 2020, spreading the purchase over several days to minimize slippage. Similarly, a major crypto VC firm used TWAP to handle a large position in Instadapp (INST), achieving a 7.5% improvement over VWAP. Kraken Pro, an advanced trading platform, offers VWAP as a built-in technical indicator, allowing traders to analyze crypto assets and optimize their trades based on volume-weighted averages.