Understanding On Balance Volume (OBV)


Introduction

On Balance Volume, commonly known as OBV, is a revered technical indicator in the world of financial trading. Developed by Joe Granville in 1963, it has since become a cornerstone for traders aiming to understand the intricate relationship between volume and price changes. In this guide, we’ll delve deep into OBV, providing expert traders with a detailed understanding and actionable insights.


The Genesis of OBV

Joe Granville introduced the OBV in his groundbreaking book “Granville’s New Key to Stock Market Profits.” His primary assertion was simple yet profound: volume often precedes price. This means that before a stock’s price sees a significant move, there’s usually a noticeable change in its trading volume.


Calculating OBV: Step-by-Step

  1. Starting Point: Begin with an initial value, typically the volume of the first trading period.
  2. Price Rise: If today’s closing price surpasses yesterday’s, add today’s volume to the previous OBV.
  3. Price Drop: If today’s closing price is less than yesterday’s, subtract today’s volume from the previous OBV.
  4. No Change: If the closing prices remain consistent, the OBV remains unchanged.

Example: Let’s say the OBV on Day 1 is 1,000. On Day 2, if the stock closes higher and has a volume of 500, the new OBV becomes 1,500. Conversely, if the stock closes lower with the same volume, the OBV would drop to 500.


Interpreting OBV: What the Numbers Tell You

  • Trends in OBV
    • Rising OBV: Indicates that volume is more robust on up days. This can be a sign of strong buying pressure.
    • Falling OBV: Suggests that volume is more substantial on down days, hinting at selling pressure.
  • Spotting Divergences
    • Bearish Divergence: When the stock price climbs, but OBV declines, it might signal a potential price reversal to the downside.
    • Bullish Divergence: If the stock price is dropping, but OBV is on the rise, it can indicate a potential upward price reversal.

    Example: Imagine a scenario where a stock has been steadily climbing for weeks, reaching new highs. However, its OBV has been on a decline. This divergence might hint at a weakening bullish momentum, suggesting that the stock could face a potential downturn soon.

  • Breakouts and OBV
    • A breakout in OBV before a price breakout can be an early indicator of an impending price movement. For instance, if OBV reaches new highs while the price is still consolidating, it might foreshadow a bullish price breakout.

Conclusion

On Balance Volume is more than just a technical indicator; it’s a window into the underlying momentum and strength of a security. By understanding and interpreting OBV trends and divergences, expert traders can gain an edge in predicting potential price movements. As with all trading tools, it’s crucial to use OBV in conjunction with other indicators and strategies for the best results.