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.
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.
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.