What Is an On-Balance Volume (OBV)?
On-balance volume (OBV) is a method of forecasting the price changes in an asset by using the element of volume change. OBV is a compounding indicator that builds up the volume on up days and detracts volume on down days to gauge the purchasing and selling pressure.
According to the OBV principle, the 24-hour volume is deemed ‘up-volume’ when an asset's price closes higher than the previous close. On the other hand, the entire day's volume is deemed ‘down-volume’ when the asset's price closes lower than its previous close. OBV will only operate on markets with exchange volume, just as other volume-based indicators, like the Klinger oscillator, money flow index, and negative volume index.
Joseph Granville is the founder of on-balance volume (OBV) metric. According to him, volume defines how the financial markets work, and the price movements occur based majorly on volume. Granville believed that the price eventually sees a huge spike (upwards or downwards) if the market volume of an asset experiences a sharp increase.
The on balance volume (OBV) can be easily calculated, depending on the closing price.
If the 24-hour closing price is below the previous close price:
- OBV = Previous OBV - Current Day’s Volume
If the 24-hour closing price is equal to the previous close price:
If the 24-hour closing price is above the previous close price:
- OBV = Current Day’s Volume + Previous OBV
It should be noted that the absolute OBV, in any case, is not important. Rather it is the OBV line that will determine the trends of the market.
- The first step is to define the trend for OBV.
- Then analyze if the current trend is correlating with the trend for the underlying asset.
- After that, you have to find support and resistance levels and mark them properly.
- Once the OBV lines that you have created break their resistance levels, accurate signals can be produced that will determine an upward or downward direction of that particular asset.
A great way to look for resistance breaks is to consider the closing prices that are the main players in the OBV realm. However, the OBV indicator can become useless for a certain period due to sharp volume spikes, and in this case, traders should wait for the settling period (the time between the trades that an order is executed in the market) to be over.
A trend reversal in the bullish or bearish direction can be predicted through divergence signals. They are based on the idea that volume always comes before price (similar to OBV). Therefore, when OBV goes down or closes lower than its previous low, a bearish divergence is formed. A bullish divergence, on the other hand, is when OBV rises and closes on a higher closing price than its previous close.
An important point to note here is that OBV, alone, is not enough to predict the bearish and bullish trends of the market. Other technical indicators, such as MACD, RSI, and ADV, are also needed for such analysis.
