On-Balance Volume

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On-Balance Volume Meaning

The On-Balance Volume (OBV) is a technical indicator that reflects the buying or selling pressure of a stock. It analyzes the trading direction. Simply put, the stocks metric tracks increase and decrease in stock volumes to predict future price movements.

OBV was developed by Joseph Granville in the 1960s. For Granville, volume was a critical factor that could predict stock price movements. Granville applied it only on stocks analysis. But soon, traders started using it to analyze other trading markets—Forex, commodity, etc.

Table of contents
  • It is a technical indicator of momentum—determines the buying or selling pressure on the asset.
  • The indicator is monitored to forecast the trade direction and near-term price changes in stocks.
  • It is an indicator of the stock market sentiment. It is either a bullish or bearish outcome.

On-Balance Volume

On-Balance Volume Indicator Strategy Explained

On-balance volume indicator helps understand the trade pressure through volumes. Changes in volume can be used as a leading indicator of stock price variations. The change could be in the volume amount or volume trend.

  • Investors use the on-balance volume strategy to analyze a stock's on-balance to detect a trend of increasing trading volume. This trend can be detected much before the rise in stock prices. Similarly, a falling volume trend indicates a consequent fall in stock price.
  • The OBV metric was introduced by Joseph Granville in 1963 in his Granville’s New Key to Stock Market Profits. Accordingto Granville, when the stock price is relatively flat, and the volume begins to increase or decrease markedly, greater amounts of trading pressure (buying or selling) would lead to a sharp price move— either upside or downside.
  • When a stock's price continues to rise, but the on-balance volume indicator begins to decline, it indicates a subsequent fall in the stock's buying momentum. Very soon, the stock price will hit its peak and start a downward trajectory.
  • It is plotted on a price chart, but the individual quantitative value remains irrelevant. The indicator is cumulative. The time interval is constant with a starting point. The OBV real value arbitrarily depends on the start date. Instead, analysts study the nature of OBV movements over time; the OBV slope line carries all of the analysis weight.
  • Analysts track large and institutional investors by assessing OBV volume numbers. Investors treat volume and price differences to showcase smart money and purchase against incorrect prevailing trends.
  • The on-balance volume formula is similar to the accumulation/distribution line. Both are momentum indicators that predict money movement by studying volume.

Interpretation

Let us look at this Bitcoin/ US Dollar Chart to understand the concept better.

Source

In the chart above, the white line denotes the OBV. It measures the selling as well as buying pressure in the market as a cumulative indicator, summing up volumes on the up days while subtracting it on the down days. When the exchange rate closes at a higher rate compared to the previous close, it is called up-volume. On the other hand, if the exchange rate closes at a lower rate compared to the prior close, one considers it down-volume.

In the chart, we can see that the OBV started increasing around 12 pm on October 15, 2021, thus reflecting positive volume pressure. This, in turn, resulted in increased price levels. That said, one can observe that after the OBV started dropping after 4:20 pm, reflecting negative volume pressure, price levels decreased too.  

If people wish to develop a clearer understanding of how the OBV indicator works, they may consider observing the various charts published on the TradingView platform.

Formula

The on-balance volume formula depends on different scenarios.

If the present-day asset's closing price > the previous day's closing price:

OBV = Previous OBV + today’s volume

When the asset's closing = the previous day's closing price:

OBV = Previous OBV (+ 0)

When the asset's closing price < the previous day's closing price:

OBV = Previous OBV – today’s volume

Example

In October 2021, Tata Power marked its high point close to 267 in BSE. Since then, it has been under-defined and ranged consolidation. It has remained inside a broad trading range of 210-250. Once again, signs of a potential uptrend are seen. The Moving Average Convergence Divergence (MACD) has shown a positive crossover. It was running bullish and above the signal line. Recent up-days witnessed above-average volumes.

The relative strength index (RSI) is neutral and does not reflect any divergence against the price. However, in pattern analysis, it is seen breaking out from a falling trend line resistance (bullish). Already, the OBV is high, even before an actual price breakout.

Frequently Asked Questions (FAQs)

Is on-balance volume a good indicator?

Since OBV is a leading indicator, it may produce forecasts. But, looking at the bigger picture—no investor can comment on what happened in terms of signals. Therefore, there is room for false positives and misinterpretations. This can potentially balance lagging indicators.

How accurate is on balance volume?

OBV provides fair feedback on major highs and lows and is very useful in measuring the breakout and breakdown potentials. In addition, it predicts bearish divergence depending on the rally.

What is a high on balance volume refer to?

A high OBV indicates positive volume pressure looking forward to higher prices. Likewise, decreasing OBV refers to negative volume pressure anticipating lower prices.