On-Balance Volume (OBV) is a momentum indicator that uses volume flow to predict changes in stock price. Developed by Joseph Granville in the 1960s, OBV adds a significant dimension to technical analysis by evaluating the relationship between volume and price movements.
Understanding the Formula
OBV Calculation
The OBV is calculated using a running total of volume, and it adds the day’s volume on up-days and subtracts it on down-days. The formula is as follows:
Components
- Previous OBV: The OBV value from the previous day
- Current Volume: The volume of the current trading day
- Closing Price: The closing price of the stock
Practical Applications of OBV
Identifying Trend Confirmation
OBV is frequently used to confirm price trends. A rising OBV during an upward price trend suggests that volume is supporting the price increase, indicating strength in the trend.
Spotting Divergences
Divergence between the OBV and the stock price can be a powerful predictor of future movements. For example, if the stock price is rising but the OBV is falling, it could signal a potential reversal.
Volume Precedes Price
One of the foundational principles behind OBV is that volume precedes price. Meaning, a significant increase in OBV may lead to a subsequent change in price direction.
Examples of OBV in Action
Bullish Indicator Example
Let’s consider a stock whose OBV shows a consistent upward trend while the stock’s price remains relatively stable. Traders may interpret this as a bullish signal, anticipating a future price breakout.
Bearish Indicator Example
Conversely, if a stock’s price is increasing but OBV is lagging or declining, it may indicate a weakening trend and potential bearish reversal.
Historical Context of OBV
Developed by Joseph Granville in the early 1960s, OBV was one of the pioneering indicators that focused on the role of volume in price movements. Granville theorized that changes in volume typically precede changes in prices, laying the foundation for modern volume analysis.
Comparisons to Other Indicators
OBV vs. Accumulation/Distribution Line
While both OBV and the Accumulation/Distribution Line consider volume, the latter adjusts for trading range, providing a refined view of money flow trends.
OBV vs. Volume Price Trend (VPT)
The Volume Price Trend (VPT) indicator scales volume by the percentage change in price, making it more sensitive to price fluctuations compared to OBV.
Related Terms
- Volume: The number of shares traded during a given period.
- Momentum Indicator: A type of technical analysis indicator that aims to identify the speed of price movements.
- Divergence: When the price of an asset is moving in the opposite direction of an indicator.
FAQs
How is OBV different from simple volume analysis?
Can OBV be used for assets other than stocks?
What are the limitations of OBV?
References
- Pring, M. J. (2002). Technical Analysis Explained. McGraw-Hill.
- Murphy, J. J. (1999). Technical Analysis of the Financial Markets. New York Institute of Finance.
- Granville, J. (1963). Granville’s New Key to Stock Market Profits. Prentice Hall.
Summary
On-Balance Volume (OBV) is a cornerstone of technical analysis, offering insights into the momentum of price movements through volume analysis. By understanding its formula, applications, and historical context, traders can better gauge market trends and potential reversals, aiding in more informed investment decisions.
