On Balance Volume

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Introduction

In his 1963 book, “New Key to Stock Market Profits” Joe Glanville introduced to the investing community On Balance Volume (OBV). OBV was designed to measures buying and selling pressure in stocks by relating price and volume. OBV is a cumulative indicator that adds volume on up days and subtracts volume on down days. It was one of the first indicators to measure positive and negative volume flow.

Granville felt that volume was the driving force behind price movements, and designed OBV to project when major moves in stocks and the market would occur. In his book, Granville explained his belief that when volume increased or decreased dramatically without any significant change in a stock’s price, then at some point the price would move upward or downward. Volume was the result of financial institutions beginning to buy stocks that retail investors would be selling. Over a period of time, volume would drive price upward and opposite would occur as the institutions began to sell their position and the retail investors would buy again.

Calculation

The OBV line is simply a running total of positive and negative volume. A period's volume is positive when the close is above the prior close. A period's volume is negative when the close is below the prior close. For Example:

  1. If today's close is greater than yesterday's close, then today's volume is added to yesterday's OBV, and is considered up volume. (If today's close > yesterday's close then OBV = yesterday's OBV + today's volume)
  2. If today's close is less than yesterday's close, then today's volume is subtracted from yesterday's OBV and it is considered down volume. (If today's close < yesterday's close thenOBV = yesterday's OBV - today's volume)
  3. And if today's close is equal to yesterday's close then today's OBV is equal to yesterday's OBV. (If today's close = yesterday's close then OBV = yesterday's OBV)
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Interpretation

The main thesis of OBV is based on the premise that volume precedes price. When volume on up days is greater than volume on down days the OBV line will rise. When volume on down days is greater than volume on up days the OBV line will fall. An upward trending OBV is the result of positive volume pressure which in return leads to higher price action. Downward trending OBV line is caused by negative volume pressure that leads to lower prices.

The key to utilising On Balance volume line is to focus on what the main concept OBV was based on and less on the actual value of OBV line. The OBV line should be analysed in similar fashion as chart analysis. Trading signals are generated by monitoring trend, support and resistance lines that formed by the OBV line.

Divergences

The divergence between OBV and price alert traders of possible a price reversal. A bullish divergence occurs when the OBV line moves higher or forms a higher low even as prices move lower or make a lower low. A bearish divergence occurs when the OBV line moves lower or forms a lower low even as prices move higher or make a higher high. 

Conclusions

The beauty of the On Balance Volume is a simple tool that allows traders to uses volume and price to monitor buying pressure and selling pressure. As with most indicators, accuracy can be improved using On Balance Volume in addition with other indicator and by employing other aspects of technical analysis. OBV should not be used in isolation. OBV is at its best when it’s combined with other technical indicators with basic pattern analysis or to confirm signals.

What makes On Balance Volume such as valuable technical analysis tool is it that combines both price and volume to confirm price action or warn of potential weakness. Traders can avoid weak trends by using OBV to identify price movements that lack of conviction by buyers and sellers.

At its simplest form, OBV is generally used to confirm price moves. The premise is that volume is higher on days when prices move higher and conversely when prices move lower. It’s the ability to visualise a simple idea that makes OBV a powerful tool for traders to use.