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Trading with the On Balance Volume Indicator

On Balance Volume (OBV) is a volume-based indicator that aims to measure the pressure buyers and sellers exert on the markets. Its approach is to add volume on days that the price rises and subtract volume on days that the price drops.

Developed in 1963 by the chartist Joe Granville it was probably the earliest example of an indicator that measured positive and negative volume flow.

This different way of looking at volume is calculated by a relatively simple formula (automatic in all current platforms):

If the closing price is above the prior close price then:

Current OBV = Previous OBV + Current Volume

 

If the closing price is below the prior close price then:

Current OBV = Previous OBV  –  Current Volume

 

If the closing prices equals the prior close price then:

Current OBV = Previous OBV (no change)

The theory on which this indicator is based is that volume precedes price. OBV goes up when volume on up days is quicker than the volume on days with a drop. The indicator falls when the volume on days with a negative price is stronger.

An OBV that is going up is a signal of positive volume pressure that can potentially lead to prices going up. The opposite situation is a signal of prices going down – falling OBV shows negative pressure from the volume.

In his papers discussing the indicator, Granville stated that he noticed that On Balance Volume moved before the price, but keep in mind that this is not always the case.

on balance volume indicator trading chart

Another thing to remember is that the value of the indicator doesn’t carry some sort of importance. It is instead the direction and the trend of the line that should be the main focus.

Matching the trend on the OBV with the trend of the instrument you’re trading comes next. If they’re the same then you might have a good chance at predicting the direction it’s headed.

Entry points are looked for by many technical analysts by identifying support and resistance lines on the OBV’s chart. Breaks and rebounds have been found to have relevance and correlation with support and resistance levels for the instrument but again – not always!

As most of the indicators we’ve covered, OBV has bullish and bearish divergences and more advanced traders use them to find indications of a trend reversal and potential entry points. This approach takes into account the notion that volume does indeed precede price movement.

To put On Balance Volume in a nutshell – you can look for a buy position when the OBV is rising at the same time as a drop or ranging price of an instrument and you can prepare for a sell position when the OBV is dropping while the price of the instrument is ranging or going up.



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