The On Balance Volume (OBV) indicator is a relatively simple SlopeCharts indicator that combines volume and price to help determine change of trend. The OBV line chart doesn’t have its own price scale. Instead, you simply need to observe the pattern of the line and how it relates to the price chart as a whole.
As strong volume accompanies rising prices, the OBV will surge higher. However, as strong volume occupies drooping prices, the OBV will push lower. The higher the volume, the more “weight” the up or down movement in price will have. The lower the volume, the less the OBV will move based on the present direction.
The general idea, then, is that volume powers prices higher or lower, and that by combining these values into a chart that takes into account both vectors, you get a more accurate view as to the true direction of a financial instrument. Specifically, if you find divergences taking place, it could indicate a subtle but important trend change.
Let’s take Bank of America as an example, back in 2011. The stock had been falling from April 2010 to December 2011, losing nearly three-quarters of its value. As the chart shows below, the price bars were continuing to weaken (lower lows) yet the OBV, represented in the lower pane, was doing just the opposite: making lower highs. This was an important signal that selling was taking place on diminishing volume, whereas buying was on growing volume.
The arrow below marks about the point where this divergence took place and the subsequent nearly 300% rise in price.
As a different example, here is Microsoft from 1999. The stock had been strong for years. However, while the price trend was clearly up, the trend in the OBV was down. This divergence spanned many months and suggested waning power behind the stock’s strength.
After one final surge higher in the first quarter of 2000, Microsoft spent the next couple of years falling to pieces. OBV provided a clear warning that a major trend change was on the way.
To see what Slopers in the comments section have been saying about this indicator, check out the archives located here.