While most indicators deal with price, very few of them deal with the volume. On-balance volume (OBV) is of the latter category. OBV is a momentum indicator that uses volume flow to forecast the upcoming changes in the stock price.
What is OBV Indicator?
Developed by Joe Granville, OBV indicator is an advanced indicator which correlates price as well as volume. OBV is actually one of the first indicators to measure positive and negative volume flow and take into account if the volume is pushing prices up or down.
The core concept behind OBV indicator is that volume precedes price. The OBV indicator adds volume on ‘up days’ and subtracts volume on ‘down days.’
- OBV rises when the volume on up days is more than the volume on down days. The rise in OBV indicates a positive volume pressure that can result in higher prices.
- OBV falls when the volume on down days is stronger than the volume on up days. The fall in OBV indicates a negative volume pressure that can foreshadow lower prices.
The figure below shows the OBV indicator.
The 3 Uses of OBV Indicator
OBV indicator is used in three primary ways
- Confirmation
- Divergence
- Breakouts
#1 Confirmation
Typically, the OBV and the price chart would look almost identical. As long as both charts move in the same fashion, the volume supports the rise or fall in price. This means that OBV can help in confirming whether the current price direction is likely to continue. The trendlines can be used to indicate the current direction.
- OBV rises whenever price rises. When both price and OBV are making higher highs and higher lows, the upward trend is likely to continue.
- OBV falls whenever price falls. When both price and OBV are making lower highs and lower lows, the downward trend is likely to continue.
The figure below shows how OBV and price follow the same direction.
For Trading: You can start new positions or add onto existing positions based on whether the price-OBV chart is moving in the same direction.
#2 Divergences
There are times when the OBV differs from the price. When such scenarios happen, it is called as a divergence and indicates that the price may potentially change direction.
Divergence is said to happen when the price is moving higher but OBV is either falling or flat, or when the price is decreasing but OBV is moving higher or staying flat.
- When price makes higher highs and OBV fails to make higher highs, the uptrend is likely to stall or fail. This is called a negative divergence.
- When price makes lower lows and OBV fails to make lower lows, the downtrend is likely to stall or fail. This is called a positive divergence.
The figure below shows price-OBV bullish divergence. While the price made a lower low, OBV made a higher low. Soon after, the price moved up.
For Trading: You can enter new positions when the divergences happen. In case of positive divergence, take long positions, and in case of negative divergence, take short positions.
#3 Breakouts
Whenever the stock is in a trading range for a while, there is a possibility that an upward or downward break might occur. OBV can be used to predict these upcoming price breaks.
- When the stock is in a range and the OBV is rising, it may indicate that accumulation may be taking place. This forecasts a possible upward breakout.
- When the stock is in a range and the OBV is falling, it may indicate that distribution may be taking place. This forecasts a possible downward breakout.
The figure below shows how OBV moved down when the price was in a range, leading to a breakdown.
For Trading: Take long positions when OBV indicates that accumulation may be happening, and take short positions when OBV indicates that distribution may be happening.
Happy Trader!
Tara
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