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Trading Indicators & Tools

OBV meaning, calculation and example

OBV meaning: Forex trading chart on Newton's cradle, showing OBV as a powerful tool for analysis.

OBV meaning?

The on-balance volume (OBV) indicator is a powerful tool used in technical analysis to track the flow of volume in and out of a security over a given period of time. Developed by Joe Granville, it’s a straightforward concept that can inform traders about market demand, potential price movements, and the strength of trends. By focusing on volume, OBV captures a market reality that can sometimes be misjudged when only looking at price action.

When an instrument's price closes higher than the previous close, all the day's volume is considered up-volume. Conversely, when the instrument's price closes lower than the previous day, all the day's volume is considered down-volume. This simple dichotomy allows OBV to accumulate a running total of up-volume or down-volume, which is then plotted on a chart. The resulting line provides a clear indication of whether volume is flowing in or out of a security, often before the price reflects these movements.

How is the on-balance volume (OBV) indicator calculated?

OBV formula:

IF[C0-C1]>0:I = +V

IF[C0-C1]<0:I = -V

OBV = OBV+I

  • If the closing price of the current bar is higher than the closing price of the previous bar, then the volume of the current bar is added to the previous OBV value. This is represented as: IF[C0-C1]>0: OBV = OBV(previous) + V.
  • If the closing price of the current bar is less than the closing price of the previous bar, then the volume of the current bar is subtracted from the previous OBV value. This is represented as: IF[C0-C1]<0: OBV = OBV(previous) - V.
  • If the closing price of the current bar is equal to the closing price of the previous bar, then the OBV remains the same, i.e., the volume is not added or subtracted.

In these formulas:

C0 refers to the closing price of the current bar.

C1 refers to the closing price of the previous bar.

V refers to the volume of the current bar.

The concept behind the OBV calculation is that volume precedes price movement, so if an instrument is seeing an increasing OBV, it is a signal that the volume is increasing on upward price moves, which can indicate upward buying pressure. Conversely, if the OBV is decreasing in a downtrend, it could signal that the sellers are gaining strength.

Example of trading with the OBV indicator

Let's say you're following a particular stock. You notice that its price has been in a steady uptrend for the past few weeks, but the OBV line has been trending downwards. This divergence between the price trend and the OBV trend could be a warning signal. The declining OBV suggests that volume is heavier on down days, indicating that selling pressure is increasing even though the price is still going up.

Based on this information, you might decide to sell your shares or avoid buying more, anticipating that the price could soon drop.

On the other hand, if the price has been in a downtrend and the OBV line starts to trend upwards, this could be a bullish signal. The rising OBV line suggests that volume is heavier on up days, which could mean that buying pressure is increasing and the price may start to rise soon.

In this case, you might decide to buy shares or hold onto the ones you already have, anticipating a potential price increase.

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Summary

The on-balance volume indicator provides traders with a unique perspective on market movements by focusing solely on volume. As you integrate OBV into your trading strategies, remember that it should not be used in isolation. It's always a good idea to use it in conjunction with other indicators and to consider the overall market context.

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FAQs

The effectiveness of the OBV indicator is context-dependent. It could be highly effective when used in conjunction with other indicators to confirm trends. However, like all indicators, it is not foolproof and should be used as part of a comprehensive trading strategy.

2. Can the OBV help predict price movements in the short term?

While OBV is not a price-predictive indicator in itself, it could provide early signals of potential price changes. Over the short term, it may highlight divergences between price and volume that could act as leading indicators.

3. Should I use the OBV indicator in isolation?

No, it is recommended to use OBV in combination with other technical indicators and chart patterns. Utilising multiple sources of analysis increases the reliability of your trading signals and improves the overall effectiveness of your strategy.

4. What type of instruments is the OBV indicator most appropriate for?

The OBV indicator could be applied to any instrument that has volume data available, including stocks, Forex, commodities, and cryptocurrencies.

5. Can the OBV indicator help identify market manipulations or artificial volumes?

Yes, because OBV is so heavily reliant on volume, it could sometimes reveal anomalies that may indicate artificial activity. Traders should be vigilant and use the OBV indicator as part of their due diligence process.

Past performance does not guarantee or predict future performance. This article is offered for general information and does not constitute investment advice. Please be informed that currently, Skilling is only offering CFDs.

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You are about to visit: https://skilling.com/row/ which is operated by Skilling (Seychelles) Ltd, under the Financial Services Authority Seychelles License No: SD042. Before opening an account, please read the terms & conditions and contact our customer support for any questions.

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