On-Balance Volume (OBV) is a technical indicator that uses volume flow to predict changes in stock prices. Created by Joseph Granville in the 1960s, OBV is based on the idea that volume precedes price movement, meaning that significant changes in volume can often signal upcoming price shifts. By understanding and applying OBV, traders can gain insights into the strength of a trend and identify potential reversals before they happen.

What is On-Balance Volume (OBV)?

On-Balance Volume is a cumulative indicator that adds volume on days when the price closes higher than the previous close and subtracts volume on days when the price closes lower. The resulting OBV line provides a running total that helps traders see whether volume is flowing into or out of a security.

Understanding OBV in Plain Language

Let’s break down how OBV works:

1. Calculating OBV:
   • OBV is calculated by adding the day’s volume to the previous OBV value if the closing price is higher than the previous day’s close. If the closing price is lower, the day’s volume is subtracted from the previous OBV value.
   • Example: If a stock’s price closes higher than the previous day and the volume was 1 million shares, that volume is added to the OBV. If the next day the stock closes lower, and the volume was 800,000 shares, that volume is subtracted from the OBV.
2. Interpreting the OBV Line:
   • Rising OBV: A rising OBV line suggests that buying pressure is increasing, often seen as a bullish sign. This means that volume is flowing into the asset, which could lead to higher prices.
   • Falling OBV: A falling OBV line suggests that selling pressure is increasing, often seen as a bearish sign. This indicates that volume is flowing out of the asset, which could lead to lower prices.

Using OBV in Trading

OBV can be a powerful tool in your trading strategy, particularly when combined with price action and other indicators:

1. Confirming Trends
   • Trend Confirmation: OBV is often used to confirm the strength of a trend. If the price is rising and OBV is also rising, it indicates that the uptrend is likely to continue, as it is supported by strong buying volume. Conversely, if the price is falling and OBV is also falling, it suggests that the downtrend is likely to continue.
   • Divergences: A divergence occurs when the price and OBV move in opposite directions. For example, if the price is making new highs but OBV is not, it could indicate that the trend is losing momentum and a reversal might be near.
2. Spotting Reversals
   • Bullish Divergence: A bullish divergence occurs when the price is making lower lows, but OBV is making higher lows. This can be an early signal that selling pressure is weakening, and a bullish reversal could be imminent.
   • Bearish Divergence: A bearish divergence happens when the price is making higher highs, but OBV is making lower highs. This suggests that buying pressure is weakening, and a bearish reversal could be on the horizon.
3. Breakout Confirmation
   • Breakouts with OBV: When the price breaks out of a support or resistance level, traders often look to OBV to confirm the breakout. If OBV rises significantly during a price breakout, it indicates strong volume support for the move, increasing the likelihood that the breakout will be sustained.
4. Identifying Accumulation and Distribution
   • Accumulation: If OBV is rising while the price is staying flat or rising slightly, it may indicate that the asset is being accumulated by investors. This suggests that a price increase might follow as buying pressure builds.
   • Distribution: If OBV is falling while the price is staying flat or falling slightly, it may indicate that the asset is being distributed by investors. This suggests that a price decline might follow as selling pressure builds.

Combining OBV with Other Indicators

While OBV is a powerful indicator on its own, its effectiveness can be enhanced when used in conjunction with other technical analysis tools:

• Moving Averages: Combining OBV with moving averages can help smooth out the OBV line and provide clearer signals. For example, using a moving average crossover on the OBV line can help confirm trend changes.
• Relative Strength Index (RSI): Using OBV alongside the RSI can help confirm overbought or oversold conditions. If OBV is rising and RSI shows the asset is overbought, it could indicate a strong uptrend, but caution is warranted.

Final Thoughts

On-Balance Volume is a versatile and insightful indicator that can provide valuable clues about the strength and direction of a trend. By incorporating OBV into your trading strategy, you can gain a deeper understanding of market dynamics and make more informed decisions. Remember, like all indicators, OBV is most effective when used in conjunction with other tools and within the context of broader market analysis.

Glossary

• On-Balance Volume (OBV): A cumulative indicator that adds or subtracts volume based on whether the asset’s price closed higher or lower than the previous close, used to gauge buying and selling pressure.
• Divergence: When the price and an indicator (such as OBV) move in opposite directions, potentially signaling a reversal.
• Accumulation: A phase where volume is increasing while the price remains relatively stable, indicating potential future upward movement.
• Distribution: A phase where volume is decreasing while the price remains relatively stable, indicating potential future downward movement.