On-Balance Volume

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Introduction

On-Balance Volume (OBV) is an indicator that marries volume and price, attempting to show when buyers or sellers are coveting a market at a certain price - measuring accumulation and distribution. Granville developed this indicator in 1963 to measure these positive and negative volume/price flows. An up-trend OBV signifies an up-trend in price and vice-versa. It is simply a running total of positive and negative volumes, where a positive volume is calculated when the price close is above the previous period close. In the following table we can see how it’s calculated. 


As you can see the OBV moves on the up and down movement of the price. A positive price close creates a +1 multiplier and a negative price close creates a –1 multiplier. The amount of change in the price doesn’t matter, it only matters that we have a plus or minus close in price. This multiplier is then used to multiply against the current periods volume forming a positive or negative number. The OBV is then calculated by adding the previous periods OBV to this positive or negative number.

Interpretation

Like Volume, OBV is a leading indicator – In theory, volume precedes price. A rising OBV indicates that positive volume is outpacing negative volume at current prices (bulls outpacing bears) and vice versa. This positive volume pressure can lead to higher prices and again vice versa. On a chart OBV will be positioned in a box under the market's price.

Research has suggested that OBV often moves before price. Chartists don’t bother about the value of OBV, just the characteristics. When interpreting OBV traders often look for the trend to confirm the security trend or divergences to signal trend changes. They will also pay close attention to support and resistance levels in both the OBV and security as support and resistance breaks in OBV sometimes precede those in price. Remember to utilise other indicators in your strategy, e.g. combine OBV with moving averages and oscillators.

OBV to Anticipate Support & Resistance Breaks

Often OBV will precede price.  In doing so it can confirm trend and anticipate when support and resistance will be broken. Volume confirms trend, which shows conviction of bears or bulls at current prices. The below RIMM chart shows OBV breaking support and resistance levels before price, allowing traders to anticipate the price level break itself.  This is advantageous if traders want to catch the break-out of a chart pattern or for building exit strategies prior to support/resistance being broken.

RIMM - OBV as a Leading Indicator, Breaking Out First

We can see this at work.  In our RIMM example above notice how OBV brakes down trend resistance before price (1) by about 15 days. I've circled the point of break in each case.  This also happened in Mar 2011. Trend support was broken first by OBV then 2 days later price broke trend support. In both these examples a new trend is started, allowing traders to enter the trade early, or gear up to exit their current trade. Just be aware that this doesn't happen in all cases.  

OBV & Divergence

Chartists will look at OBV-price divergences to signal a trend reversal and are based on the principle that Volume precedes prices. In the below chart we have an example of 2 bearish OBV divergences in SPY (S&P ETF). Clearly selling volume has in general outpaced buying volume from Feb 18th to August 2011, indicating a bearish outlook. However, price is making higher highs on this increase in selling. This may alert traders that a reversal in price may take place as selling vol. continues to outpace buyers (there is more selling conviction). At the very least, there is waning interest at these prices.

S&P 500 ETF - OBV Divergence Signals Waning Interest & Possible Reversal

Breaking it down, divergence (1) is making higher price highs, but OBV (1) is making lower highs. This divergence precedes a price drop in May, as does divergence (3) preceding a bearish move in July. Together these divergences show a strong signal for an eventual reversal. This happens big style in late July. Although this chart doesn’t show it – look out for OBV breaking resistance before price. This is another indicator that price will reverse.

Note. Economic indicators showing the world economy slowing in 2011 instigated the initial sell off. This sell off persisted as worries about European sovereign debt continued to deepen. All this bad news resulted in a global market crash in summer 2011. The worry was magnified, as the banking crisis of 2008-09 was fresh in the memory.

You may also notice a large head and shoulders and double top chart pattern. These patterns were also bearish indicators. I’ve highlighted these on a separate SPY chart to avoid confusion.

To Sum UP

On-Balance Volume needs to be utilised with other indicators as it doesn't supply trading signals - using oscillators and chart pattern analysis along with volume or OBV is always a good move. Like volume, it points to the psychological state of the market and is generally used to foreshadow or confirm price moves by confirming or denying trend.  

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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Introduction

On-Balance Volume (OBV) is an indicator that marries volume and price, attempting to show when buyers or sellers are coveting a market at a certain price - measuring accumulation and distribution. Granville developed this indicator in 1963 to measure these positive and negative volume/price flows. An up-trend OBV signifies an up-trend in price and vice-versa. It is simply a running total of positive and negative volumes, where a positive volume is calculated when the price close is above the previous period close. In the following table we can see how it’s calculated. 


As you can see the OBV moves on the up and down movement of the price. A positive price close creates a +1 multiplier and a negative price close creates a –1 multiplier. The amount of change in the price doesn’t matter, it only matters that we have a plus or minus close in price. This multiplier is then used to multiply against the current periods volume forming a positive or negative number. The OBV is then calculated by adding the previous periods OBV to this positive or negative number.

Interpretation

Like Volume, OBV is a leading indicator – In theory, volume precedes price. A rising OBV indicates that positive volume is outpacing negative volume at current prices (bulls outpacing bears) and vice versa. This positive volume pressure can lead to higher prices and again vice versa. On a chart OBV will be positioned in a box under the market's price.

Research has suggested that OBV often moves before price. Chartists don’t bother about the value of OBV, just the characteristics. When interpreting OBV traders often look for the trend to confirm the security trend or divergences to signal trend changes. They will also pay close attention to support and resistance levels in both the OBV and security as support and resistance breaks in OBV sometimes precede those in price. Remember to utilise other indicators in your strategy, e.g. combine OBV with moving averages and oscillators.

OBV to Anticipate Support & Resistance Breaks

Often OBV will precede price.  In doing so it can confirm trend and anticipate when support and resistance will be broken. Volume confirms trend, which shows conviction of bears or bulls at current prices. The below RIMM chart shows OBV breaking support and resistance levels before price, allowing traders to anticipate the price level break itself.  This is advantageous if traders want to catch the break-out of a chart pattern or for building exit strategies prior to support/resistance being broken.

RIMM - OBV as a Leading Indicator, Breaking Out First

We can see this at work.  In our RIMM example above notice how OBV brakes down trend resistance before price (1) by about 15 days. I've circled the point of break in each case.  This also happened in Mar 2011. Trend support was broken first by OBV then 2 days later price broke trend support. In both these examples a new trend is started, allowing traders to enter the trade early, or gear up to exit their current trade. Just be aware that this doesn't happen in all cases.  

OBV & Divergence

Chartists will look at OBV-price divergences to signal a trend reversal and are based on the principle that Volume precedes prices. In the below chart we have an example of 2 bearish OBV divergences in SPY (S&P ETF). Clearly selling volume has in general outpaced buying volume from Feb 18th to August 2011, indicating a bearish outlook. However, price is making higher highs on this increase in selling. This may alert traders that a reversal in price may take place as selling vol. continues to outpace buyers (there is more selling conviction). At the very least, there is waning interest at these prices.

S&P 500 ETF - OBV Divergence Signals Waning Interest & Possible Reversal

Breaking it down, divergence (1) is making higher price highs, but OBV (1) is making lower highs. This divergence precedes a price drop in May, as does divergence (3) preceding a bearish move in July. Together these divergences show a strong signal for an eventual reversal. This happens big style in late July. Although this chart doesn’t show it – look out for OBV breaking resistance before price. This is another indicator that price will reverse.

Note. Economic indicators showing the world economy slowing in 2011 instigated the initial sell off. This sell off persisted as worries about European sovereign debt continued to deepen. All this bad news resulted in a global market crash in summer 2011. The worry was magnified, as the banking crisis of 2008-09 was fresh in the memory.

You may also notice a large head and shoulders and double top chart pattern. These patterns were also bearish indicators. I’ve highlighted these on a separate SPY chart to avoid confusion.

To Sum UP

On-Balance Volume needs to be utilised with other indicators as it doesn't supply trading signals - using oscillators and chart pattern analysis along with volume or OBV is always a good move. Like volume, it points to the psychological state of the market and is generally used to foreshadow or confirm price moves by confirming or denying trend.  

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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