On Balance Volume (OBV) is a volume-based technical analysis indicator for momentum that can be used for any security for which volume is available. The OBV is one of the best indicators to use when determining the strength of a trend. It is intended to show the cumulative flow of money into a stock and shows whether there are more buyers or sellers, and helps determine the market’s general direction.
What Is The On Balance Volume Indicator?
The On Balance Volume indicator was developed by Joe Granville and is designed to identify the momentum of a stock by comparing volume to price. It represents the cumulative total of volume, positive and negative, for a security. OBV is often used to determine if there are more buyers or sellers in a given security at a certain time. As a trend following momentum indicator, OBV can be used to identify when a trending security is ready for a turning point or reversal.
How To Use OBV
The On Balance Volume Indicator was developed by Granville because he believed that volume was the key force behind the movement of markets and that the tool could be used to project the timing of major moves based on volume changes. The theory behind this indicator is that volume precedes price. By understanding changes in volume you will be able to spot a change in the bearish or bullish sentiment of a security. Therefore, if you follow the OBV indicator, you will be able to predict changes in the price of a security before they happen.
Despite a numerical representation and the ability to plot OBV on a price chart, an individual OBV is not a relevant piece of information. Instead, the primary purpose of the On Balance Volume is to predict turning points and reversals in an upward or downward trending market. That means that the slope of the On Balance Volume indicator is the true value and that the movements over time are what can be used to make timing decisions.
Analysts can review volume numbers on the OBV to track the movements of large, institutional investors, which have the weight to move a stock’s price through its transactions.
Accumulation/Distribution (A/D) is a similarly-used momentum indicator for predicting movement based on volume. But the calculation of OBV differs greatly from the formula used for A/D.
Without a companion indicator, On Balance Volume may produce false signals. Because OBV is a leading indicator, it is limited in its ability to explain signals and is often paired with a lagging indicator such as a moving average line to identify and confirm breakouts.
Historical Examples Of The OBV Indicator
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 higher lows. 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.
SlopeCharts On Balance Volume Tool
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.
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