Time-Weighted Average Price

The time-weighted average price, or TWAP, is a trading algorithm used in traditional finance tools. It works on the basis of the weighted average price and executes large trade orders by producing an average execution price for the period specified by the user.

TWAP executions are carried out progressively at regular intervals. TWAP orders are crucial in algorithmic trading because they disperse deals equally across a set period. It reduces market effect and serves as a standard for measuring execution performance. This qualifies time-weighted average price strategies as appropriate for traders looking to maintain pricing constancy over long periods.

Time-weighted Average Price (TWAP) is a trading strategy used to execute large trade orders by calculating a weighted average price over a defined time interval. It allows traders to break down substantial orders into smaller ones at beneficial TWAP prices. The aim is to achieve an execution price close to the TWAP for the specified period. In other words, it helps to achieve an overall average price instead of locking in prices that are closely tied to real-time market values.

The method involves executing trades evenly over a set period to attain an average price. This is especially important when huge orders are required to purchase large quantities of a supply. Bids can have an impact on liquidity pools and asset prices. Placing many orders at once may raise demand and increase market prices, resulting in higher costs for dealers. It, therefore, deliberately breaks large orders into smaller transactions that are completed regularly over an agreed-upon time frame. TWAP distributes its impact on market price and secures a favorable or beneficial average cost.

TWAP orders are intended not only to conduct huge deals without significantly affecting market prices but also to decrease market disruptions and prevent price increases. They function as a passive execution system that waits patiently for a time when market prices align with favorable levels, resulting in a less aggressive impact on market conditions. This strategy is appropriate for traders who want predictable and consistent trading patterns. In essence, it provides for even distribution of large orders, minimizing unexpected price increases caused by one-time order placements.

The time-weighted average price strategy works for a set length of time (if start and end timings are stated) or until the target quantity is reached. The strategy position's frequency of openings is determined by factors such as delay, market price, and price limit parameters. This strategy can be used in both day-to-day and long-term trading.

Typical TWAP price (per day) = (Closing price + High price +Low price +Opening price)/4

Taking these 4 prices can give us the value of the average price of each day.

Suppose the length of the period is for a longer term, say, a month; then the calculation will be done to get the average of 30 days. In detail, 

Average TWAP of 30 days (average price of the first day + the average price of the second day + the average price of the third day........ average price of the thirtieth day)/30.

Let us understand the concept better with a few examples:

Example #1

Suppose Dan is a trader who wants to buy 10,000 shares of XYZ Company. He is employing the strategy for the first time and does it for a day.

Let's assume that his closing price, high price, low price, and opening price are $205,250,190 and $200, respectively.

We can calculate it as follows:

Typical TWAP price = (closing price + high price + low price + opening price) / 4

Given inputs:

• Closing price = $205
• High price = $250
• Low price = $190
• Opening price = $200

Substituting these values into the formula, we get:

• TWAP price = ($205 + $250 + $190 + $200) / 4
• TWAP price = $845 / 4
• TWAP price = $211.25

Therefore, the TWAP price for Dan is $211.25.

Dan can minimize market impact by spreading his 10,000 shares order over time, such as 500 or 1,000 shares per hour or minute. This approach helps achieve better execution prices and reduces the risk of significant market impact with a single large trade. The TWAP value serves as a reference point for Dan to determine appropriate prices for each portion of the order. Here, the TWAP value is $211.25. He can place multiple buy orders at or below the TWAP price for each portion of the order, potentially benefiting from price fluctuations and securing more favorable average execution prices. Dan must carefully consider the timing, duration of trade, and execution strategy, considering market conditions, liquidity, risk management, and specific trading objectives.

Example #2

In an article published on July 11, 2024, there was an announcement witnessing the high trading activity on the Solana (SOL) blockchain. It was a detection alert of TWAP happening, and the pattern had been noticed across all platforms, such as Coinbase, Gate.io, Binance, and OKX. The trigger was the massive amount of SOL bought through automated methods. This spread out the purchases over time, but the buy order was large, and hence, little impact was seen on the prices.

Thus, while trading patterns using automated orders were executed on Coinbase, Binance, Gate.io, and OKX. Binance's trading behavior was marked with a red indicator when compared to the other exchanges. This disparity could reflect a variety of market strategies or conditions unique to Binance.