Everything You Need to Know About OBV




Introduction

On Balance Volume (OBV) measures buying and selling pressure as a cumulative indicator that adds volume on up days and subtracts volume on down days. OBV was developed by Joe Granville and introduced in his book 1963, Granville's New Key to Stock Market Profits. It was one of the first indicators to measure positive and negative volume flow. Chartists can look for divergences between OBV and price to predict price movements or to confirm price trends.

The On Balance Volume (OBV) line is simply a running total of positive and negative volume. A period's volume is positive when the close is above the prior close. And it will be negative when the close is below the prior close.

BREAKING DOWN 'On-Balance Volume (OBV)'
The theory behind OBV is based on the distinction between smart money – namely, institutional investors – and less sophisticated retail investors. As mutual funds and pension funds begin to buy into an issue that retail investors are selling, volume may increase even as the price remains relatively level. Eventually, volume drives the price upward. At that point, larger investors begin to sell, and smaller investors begin buying.

Granville theorized that volume precedes price. OBV rises when volume on up days outpaces volume on down days. OBV falls when volume on down days is stronger. A rising OBV reflects positive volume pressure that can lead to higher prices. Conversely, falling OBV reflects negative volume pressure that can foreshadow lower prices. Granville noted in his research that OBV would often move before price. Expect prices to move higher if OBV is rising while prices are either flat or moving down. Expect prices to move lower if OBV is falling while prices are either flat or moving up.

The absolute value of OBV is not important. investors should focus on the characteristics of the OBV line. First define the trend for OBV. Second, determine if the current trend matches the trend for the underlying security. Third, look for potential support or resistance levels. Once broken, the trend for OBV will change and these breaks can be used to generate signals. Also notice that OBV is based on closing prices. Therefore, closing prices should be considered when looking for divergences or resistance breaks. And finally, volume spikes can sometimes throw off the indicator by causing a sharp move.

1. If today's closing price is higher than yesterday's closing price, then: Current OBV = Previous OBV + today's volume

2. If today's closing price is lower than yesterday's closing price, then: Current OBV = Previous OBV - today's volume

3.If today's closing price equals yesterday's closing price, then: Current OBV = Previous OBV

Trend Confirmation

OBV can be used to confirm a price trend, upside breakout or downside break. The chart for Best Buy (BBY) shows three confirming signals as well as confirmation of the price trend. OBV and BBY moved lower in December-January, higher from March to April, lower from May to August and higher from September to October. The trends in OBV matched the trend in BBY.

OBV also confirmed trend reversals in BBY. Notice how BBY broke its down trend line in late February and OBV confirmed with a resistance breakout in March. BBY broke its up trend line in late April and OBV confirmed with a support break in early May. BBY broke its down trend line in early September and OBV confirmed with a trend line break a week later. These coincident signals indicated that positive and negative volume were in harmony with price.
Sometimes OBV moves step-for-step with the underlying security. In this case, OBV is confirming the strength of the underlying trend, be it down or up. The chart for Autozone (AZO) shows prices as a black line and OBV as a pink line. Both moved steadily higher from November 2009 until October 2010. Positive volume remained strong throughout the advance.

Conclusions

On Balance Volume (OBV) is a simple indicator that uses volume and price to measure buying pressure and selling pressure. Buying pressure is evident when positive volume exceeds negative volume and the OBV line rises. Selling pressure is present when negative volume exceeds positive volume and the OBV line falls. Chartists can use OBV to confirm the underlying trend or look for divergences that may foreshadow a price change. As with all indicators, it is important to use OBV in conjunction with other aspects of technical analysis. It is not a stand alone indicator. OBV can be combined with basic pattern analysis or to confirm signals from momentum oscillators.





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