What is On-balance volume indicator(OBV) ?

The on-balance volume (OBV) is a technical momentum indicator that measures buying and selling pressure as a cumulative signal, adding volume on up days and subtracting it on down days. It was designed on the basis that volume plays a key factor in stock market prices.

This indicator was first developed by Joseph Granville and published in the 1963 book Granville’s New Key to Stock Market Profits. It’s believed to be one of the first indicators that can measure positive and negative volume flow.

How to read and use the On-balance volume (OBV) indicator

In an ideal situation, the volume should rise in the direction of the trend, which means that in an uptrend market, the volume must rise along with the rising price, and in a downtrend market, the volume must rise when the price goes down. This confirms the quality and reliability of a given trend.

The market moves in an uptrend as the OBV line rises, while the market moves in a downtrend when the OBV line drops.

The cumulative characteristic of the On-balance volume indicator and the time interval remaining the same from a specific starting date explain why the OBV value is not of much importance. Traders should focus more on the trend of the OBV line when analyzing the market.

Volume in stocks indicates the number of stocks that have been traded or exchanged between buyers and sellers over a given period of time.

Sometimes the stock price will increase but the volume is low, meaning the traders are not interested in that stock. The stock price can also decrease at a higher volume than its average volume. This happens when there is a short build-up in the market, presenting a good opportunity to sell the stock.

The negative on-balance volume(OBV) means the closing price is below the prior close.

The positive on-balance volume(OBV) means the closing price is above the prior close.

On-balance volume (OBV) calculation

Since the on-balance volume (OBV) indicator measures the cumulative selling and buying pressure, adding volume on up days and subtracting it on down days, we will use three methods in our calculation.

If today’s closing price is greater than yesterday’s close then:
OBV = Yesterday’s OBV + Today’s Volume

If today’s closing price is less than yesterday’s close then:
OBV = Yesterday’s OBV – Today’s Volume

If today’s close is equal to yesterday’s closing price then:
OBV = Yesterday’s OBV

On-balance volume (OBV) indicator trading strategies

There are several strategies that can be used when trading with the On Balance Volume indicator. We will look at three common strategies and one advanced strategy.

1.On-balance volume (OBV) divergence strategy

The divergence trading strategy is widely used by many traders because it can be applied to different indicators like the commodity channel index (CCI), MACD, RSI, etc. This strategy involves either positive or negative divergence.

A bullish OBV divergence occurs when OBV moves higher or forms a swing higher high point even as the prices form a swing lower low. A bearish OBV divergence occurs when OBV moves lower or forms a swing lower low point even as prices form a swing higher high.

Traders should anticipate a possible reversal when they note a divergence between price and balance volume.

FIG 2: On balance volume (OBV) indicator negative divergence

2.On-balance volume (OBV) progressive breakout strategy

Stock price and volume are expected to keep on rising together. It reaches a time when we see that price cannot break the previous high in the market, but the OBV line has broken the previous high. This is called the “progressive breakout strategy.”

This shows that although the price has made a slight move on the upward side, the market volume is so high that it is forcing the OBV to break out earlier than the market.

This is an indication of price, which tells us that price will also break above the previous high because of the high volume in the market.

FIG 3: On balance volume (OBV) indicator progressive breakout

3.On-balance volume progressive breakdown strategy

Price and On Balance Volume, both in a downtrend market, are expected to move in the same direction, making lower highs and lower lows, respectively.

In some cases, the price will fail to break the previous swing low area while the on-balance volume will break past the previous low. This is called “progressive breakdown.”

A progressive breakdown usually indicates the price will break the low point of the market because of the weakness in price.

FIG 4: On balance volume (OBV) indicator progressive breakdown.

Advanced On-balance Volume (OBV) indicator strategy

Trading professionally requires one to have an edge in the market. The OBV indicator can only show us the strength and momentum of the market, whether it is in a strong downtrend or uptrend.

To be able to make a high-probability trade, you also need to know the direction of the market, and this is why we will introduce the Stochastic indicator. This combination will help us to trade both the progressive breakout and breakdown in a more advanced way.

Step 1: To make a buy option or go long in the market, wait for a progressive breakout to occur.

STEP 2: To confirm the progressive breakout, look for a positive divergence on the stochastic indicator in correlation to the market.

STEP 3: Take a long position, targeting a 1:2 risk to reward ratio putting your stop loss just below the last swing low point before the breakout on the on-balance volume indicator.

FIG 4: On balance volume (OBV) indicator progressive breakout with a positive stochastic divergence buying opportunity

When taking a short trade in the market, we will also use the same indicators but in this case, we will use the stochastic indicator to confirm the progressive breakdown signal in the market.

STEP 1:To make a sell option or go short in the market, wait for a progressive breakdown to occur.

STEP 2: To confirm the progressive breakdown, look for a negative divergence on the stochastic indicator in correlation to the market.

STEP 3: Take a short position, targeting a 1:2 risk to reward ratio putting your stop loss just above the last swing high point before the breakdown on the on-balance volume indicator.

FIG 4: On balance volume (OBV) indicator progressive breakdown with a negative stochastic divergence selling opportunity

Conclusion

The actual value of the On balance volume indicator is not important; traders should be keen on the market direction.

• When both price and OBV are making higher highs and higher lows, the upward trend is likely to continue so you should prepare to take a long position,add to your position or let your trades run more comfortably.
• When both price and OBV are making lower high and lower lows, the downward trend is likely to continue so prepare to go short,close your long position trades or let your short position trades run comfortably.
• During a ranging market, if the On balance volume indicator is rising, accumulation may be taking place so be watchful for a possible upward breakout of the range.
• During a ranging market, if the On balance volume is falling, distribution may be taking place and as atrader anticipate for a downward breakout of the range.
• When price continues to make higher highs but the OBV doesnt make a higher high, then the uptrend is likely to be coming to an end. This is called a negative OBV divergence.
• When price continues to make lower low and OBV doesnt make a lower low, then downtrend is likely to be coming to an end. This is called a positive OBV divergence.

Watch the On Balance Volume video below to understand other strategies to use with the OBV indicator.

Relevant resources

Joseph E. Granville. “Granville’s New Key to Stock Market Profits