What is On Balance Volume (OBV) | How to Trade

The OBV, or On-Balance Volume, is a technical indicator used in the realm of financial trading, primarily for stocks and forex. Joe Granville introduced it in his 1963 book “New Key to Stock Market Profits.”

It offers traders insights into the flow of volume in relation to price changes, aiming to show when assets are being accumulated or distributed. The main premise behind OBV is that volume can indicate strong moves in price before they occur.

What it is and what it shows
OBV is a cumulative indicator. At its core, it keeps a running total of volume and adjusts this total based on whether prices move up or down.

Here’s a simple breakdown:

• If today’s closing price is higher than yesterday’s closing price, then
  • OBV = Previous OBV + Today’s Volume
• If today’s closing price is lower than yesterday’s closing price, then:
  • OBV = Previous OBV – Today’s Volume

• If today’s closing price is equal to yesterday’s closing price, then:
  • OBV remains the same.

The basic idea is that when volume is increasing in the direction of the trend, it confirms the trend. For instance, if the price is going up and the OBV is going up as well, this is a bullish sign. Conversely, if the price is going down and OBV is decreasing, this is bearish.

How to trade it
The OBV can be used in multiple ways for trading:

• Trend Confirmation: As previously mentioned, if the price and OBV are moving in the same direction, it confirms the strength of the trend. If they diverge (e.g., prices go up but OBV goes down), it could be a sign that the trend is weakening and might reverse.

Example: If a stock is rising but OBV starts to plateau or decrease, this could be an early sign that upward momentum is waning and a potential reversal or pullback might be near.

• Bullish and Bearish Divergences: These are potent signals provided by OBV. A divergence occurs when the price is making new highs/lows, but the OBV isn’t.

Example: If a stock makes a new high but the OBV doesn’t surpass its previous high, it’s a bearish divergence. Conversely, if a stock makes a new low but the OBV doesn’t make a new low, that’s a bullish divergence. These divergences can indicate a potential price reversal.

• Breakouts and Breakdowns: OBV can help validate breakouts or breakdowns. For instance, if a stock price breaks above a resistance level and the OBV is also trending up, it’s more likely a genuine breakout.

Example: A stock breaks out of a consolidating pattern (like a triangle). If the OBV also shows a strong upward move, traders may consider this a valid breakout and anticipate further price appreciation.