The On-balance Volume (OBV) is a technical indicator that measures buying and selling pressures to make predictions on a stock’s price movements. This is a pure momentum indicator used by traders and analysts for stocks, commodities, indices and Forex. It is one of the most popular indicators used to detect trading opportunities.
OBV was first mentioned in 1963 by Joseph Granville in his book called ‘Granville’s New Key to Stock Market Profits’. Granville considered volume to be a key force behind market changes. He came up with the idea of OBV to predict major market movements.
This article helps you delve deeper into OBV, how it works, its formula, examples, uses, limitations and what a change in OBV indicates. Read on!
On-balance volume (OBV) adds volume on up days while subtracting volume on down days to measure trading pressures. For a particular security, when its price closes at a higher value than the previous day’s, that day’s volume is the up-volume. In contrast, when the prices close at a lower value, all of that day’s volume is considered down-volume.
Investors can check a stock’s volume to determine where its price is headed. Many consider volume to be a reliable indicator as it denotes the crowd sentiment that can predict a bullish or a bearish phase. The on-balance volume indicator shows clear signals that investors and traders can use.
While a rise in trading volumes indicates a possible rise in stock prices, falling volumes indicate a lowering of prices. When volumes support price movement, it makes for reliable directional signals and creates convergence. On the other hand, an opposing action creates divergence, indicating that market forces are in conflict with each other.
To calculate OBV, one must add the day’s volume of a security if the price increases upon the closing of the market. On the other hand, if the day’s closing price goes down, one must subtract the day’s volume from the asset’s OBV of the previous day.
The following are the formulas for on-balance volume calculation:
OBV = OBV on previous day + today’s trading volume
OBV = OBV on previous day + 0
OBV = OBV on previous – today’s trading volume
Let’s say ABC Pvt Ltd is a company whose shares have shown the following closing prices and volumes over 10 days from August 1, 2022. Let us assume that the OBV on August 1 is 0 for ease of calculation.
|Date||Up-Down||Closing Price||Trading Volume|
As we can see from the above table, August 2, 3, 4, 5, 9 and 12 are up-days, so trading volumes will be added to the OBV. In contrast, August 8, 10, 11 and 16 are down days, so trading volume will get subtracted.
According to this table, OBV for these 10 days will be:
The following points will elaborate on the advantages of using OBV in trading:
The following are some of the limitations of using OBV as a trading indicator:
Checking the on-balance volume is quite easy as most trading platforms have this as an in-built function. It is important to remember that the OBV chart is effective when the price of an asset is moving upwards and downwards. These charts are not suitable when the price trends keep changing, or the markets are consolidating.
With some platforms, you may need to check whether the OBV indicator’s timeline is the same as that of the price charts. For example, if you are checking a daily price chart, you will not want to select the weekly OBV.
You do not need to know the exact value of OBV to interpret it. All you need to do is apply it on price charts. The on-balance volume indicator works reliably when used with other indicators, such as the relative strength index and moving averages.
As mentioned before, the value of the on-balance volume is not important. Its value can be negative, positive or zero. However, its rate and direction are indicators of a noticeable change.
The following points will discuss the various OBV and price values and what they indicate:
The following things can happen due to a divergence:
The following are some of the rules to keep in mind when using on-balance volume:
If the OBV is moving noticeably in a certain direction, it could be a sign of a large change in that direction. Watching the trends of price and OBV is an easy way to spot trading opportunities and signs of divergence.
As mentioned before, OBV works well when used with other indicators, such as moving averages. One can also use pattern analysis to increase the robustness of trading signals with on-balance volume.
In many cases, when price movement does not correlate with OBV, it indicates a potential reversal. Often, volume swings precede a massive change in prices, which could result in a great trading opportunity.
When prices decline but OBV advances, it indicates a bullish reversal. On the other hand, a bearish reversal usually happens when an asset’s price starts advancing, but OBV declines. A possible buying or selling opportunity can arise during such situations.
On-balance volume is a useful indicator for large changes in the market. It uses volume changes to make price predictions and assess market sentiments. You can follow this metric along with other technical analysis tools to predict bullish or bearish changes in the market and spot trading opportunities.
Ans: Traders use the OBV indicator mainly because it lets them judge if a stock’s rising prices are due to a huge uptrend or a false move in the wrong direction. When a stock’s price increases despite having low volumes, such upward movements are not sustainable. Thus, people use OBV to get a clear picture of price strength.
Ans: OBV shares similarities with AD curves as both are momentum indicators that use volume changes to predict price movements. However, AD measures the net inflows and outflows of money for particular security using the money flow multiplier and volume.
Ans: The OBV value is cumulative, and it mostly depends on the starting date. Changing this would arbitrarily change the OBV value. Therefore, analysts only refer to the OBV value on a price chart and not the numerical value.
Ans: Momentum indicators are technical analysis tools that measure the rate at which stock prices fall or rise. It is a very useful indicator for determining a stock’s strength or weakness, especially in rising markets.
Ans: The moving day average of a share is its constantly updated average price. One can choose any time period to measure a stock’s moving day average, which helps to form a customisable indicator that filters out unnecessary information about price fluctuations.
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
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