What is On-Balance-Volume (OBV)?
The on-balance volume (OBV) is a trading indicator that compares the stock’s price movement with its volume over a given period. The OBV indicator was developed in the early 1970s by Joe Granville and is used to identify changes in momentum and predict future price movements. It is a cumulative indicator, which means that its value increases each day as the volume of the stock increases. OBV is typically plotted above a chart of the stock’s price movement to help traders identify changes in momentum and make more informed trading decisions. The OBV indicator can be applied to any timeframe, but most traders use it on daily and weekly charts. You can also apply the indicator to intraday charts, but keep in mind that sudden movements in volume on shorter timeframes may be due to a single event, such as a corporate announcement or analyst conference call. When you use the indicator on a daily or weekly chart, you can get a better idea of the overall strength of the trend and how long it may last.
How does OBV work?
The OBV indicator has three primary components: the OBV line, the zero line, and the divergence line.
The OBV line represents the total volume of a stock over time. When the OBV line rises, it means that there is more volume associated with a price increase. Conversely, when the OBV line falls, it means that more volume is associated with a price decline.
The zero line, which is marked as “0” on the graph, represents the expected change in the OBV line when there is no change in the stock’s price.
The divergence line is created by subtracting the OBV line from the zero line. The divergence line is used to identify changes in momentum and determine when the trend is about to reverse. When the OBV line and the zero line are rising together, it indicates that the stock is experiencing an increase in volume without a corresponding price increase. When the divergence line is rising, it indicates that the stock is experiencing an increase in volume without a corresponding price increase. When the divergence line is falling, it indicates that the stock is experiencing an increase in price without a corresponding increase in volume. And when the zero line and the divergence line are falling together, it indicates that the stock is experiencing a decrease in volume without a corresponding decrease in price.
Benefits of Using OBV
Traders like the OBV indicator because it helps identify changes in momentum, which can lead to more profitable trading decisions. When the OBV indicator rises while the stock’s price is falling, it can indicate that the stock’s trend is losing momentum and traders should consider exiting their positions. When the OBV indicator falls while the stock’s price is rising, it can indicate that the stock’s trend is losing momentum and traders should consider entering their positions. Traders can also use the indicator to anticipate changes in trends. A change in the direction of the divergence line can indicate that a change in trend is coming. The indicator’s ability to identify changes in momentum and anticipate changes in trend can help traders make more profitable trading decisions.
How to Use the OBV Indicator
To use the indicator, you first need to calculate the indicator’s values for each day. The formula is OBV (day) = volume (day) / price (day) If you are using the daily closing price, then you can use the following formula: OBV (day) = volume (day) / closing price (day) The first thing you should do after calculating the indicator for each day is to draw a trendline on your chart. You can use whatever line type you prefer, but most traders prefer a straight line. Next, you need to determine whether the trend is increasing or decreasing. You can do so by drawing a straight line from the beginning of the trendline to the end of it. If the line falls above the trendline, it means that the trend is increasing. If the line falls below the trendline, it means that the trend is decreasing. The next step is to compare the current trendline with the previous one to determine whether a change in trend is coming. If the new trendline is higher than the previous one, it means that the trend is accelerating. If the new trendline is lower than the previous one, it means that the trend is decelerating. The final step is to interpret the indicator’s current reading. If the reading is above 100, it means that the stock’s price is rising faster than the volume. Conversely, a reading below 100 means that the price is rising slower than the volume.
OBV Indicator and Momentum
The indicator works best when used together with the concept of momentum. Momentum is the strength of a trend and can be identified by the indicator. When the trend is strong and the indicator’s value is above the historical average, it indicates that the trend is strong. When the indicator’s reading is below the historical average but rising, it indicates that the trend is weakening. Traders can use the indicator’s reading to determine whether the trend has enough strength to last for several more weeks or months. If the indicator’s reading is below the historical average but rising, it indicates that the trend is weakening and could end within a few weeks or months. If the indicator’s reading is significantly below the historical average, it indicates that the trend is very weak and could end within a few days or weeks.
