Positive or negative value is assigned to the volume depending upon the price being higher or lower on that day compared to the previous day. If the price is higher than the last close then the volume is assigned a positive value, and if the close is lower than previous, then it gets assigned a negative value. As a result, when price goes up, OBV goes up as well & vice-versa. A negative divergence occurs if the OBV fails to go past its previous rally high.
The concept behind using the OBV is that when price is going up, it attracts greater volume as compared to day’s when the price is going down. The total volume is maintained by adding each day volumes to it based on whether it’s the up-volume or down-volume. The OBV line should be kept in mind while making use of this indicator and not the real volume numbers.
It basically helps in detecting if a particular currency is being accumulated by buyers or sold by sellers. On Balance Volume should be used in conjunction with other indicators.
An uptrend can be confirmed by an upward sloping OBV while downtrend gets confirmed if the slope is downward sloping. If the divergence exists in the form that the price is going up while the OBV is going down, then it is safe to assume that the smart investors have started to exit their positions and change of trend is not too far.
Calculation
OBV is calculated as: If today’s close is greater than yesterday’s close then:
OBV(C) = OBV(C-1) + Volume(C)
If today’s close are less than yesterdays close then:
OBV(C) = OBV(C-1) + Volume(C)
If today’s close is equal to yesterdays close then:
OBV(C) = OBV(C-1)
Where:
OBV(C) = is the indicator value of the current period
OBV(C-1) = is the indicator of the previous period
Volume(C) = is the volume of the current bar
Example
This chart shows how the OBV line can be used as confirmation of a price trend. The peak in August was followed by lower price movements that corresponded with volume spikes, thus, implying that the downtrend was going to continue.
1. Bearish divergence occurs when the price is going up while the tops of indicators are going down. In contrast, a bullish divergence occurs when the indicator is going up while the price is going down.
2. As none of the indicators can predict the markets with 100% accuracy, so it is always safe to combine a few indicators and take confirmations from them also.
Ranging Market
During a ranging market watch for a rising or falling On Balance Volume:
- Rising OBV line indicates an upward breakout.
- Falling OBV indicates a downward breakout.
Trending Market
A rising On Balance Volume confirms an up-trend and a falling OBV confirms a down-trend.
If OBV and price have started to move in the upward directions, it shows the market bottom has been formed.
On the other hand, if price and OBV started moving down, it suggests the market has formed the top.
- OBV can be used to look for the trend in the indicator. An Upward sloping OBV line signifies a healthy move in the security while a zigzag or sideways trend represents indecision or reversal of a trend. Ultimately, the price will follow the OBV line, if it had not been doing that already.
- Plotting OBV The OBV line is plotted around the bottom of the price chart with the idea that the price line will ultimately follow the same trend.
- OBV Breakouts If there are sideway movements then OBV line mostly breaks out, first indicating the direction of the future trend and thereby giving an early hint of where the price is headed.
It gives direction to the volume signifying whether it is the buying or selling pressure which is dominating the market. It can be used to see changes in the sentiments of investors, divergences etc.
- Cumulative total of volume of additions and subtractions represents the OBV.
- OBV adds the volume to the cumulative total if the close of the price is positive and subtracts the volume if the close is negative.
- An OBV graph begins with 0 and then starts. The numbers are not important in the OBV graph. The only thing which a trader is supposed to see is the direction of the OBV line as the numbers do not work in the relative sense.
- It is mainly used to look for the various divergences and to look for the trend confirmations.
An Example
Let’s take an example of EUR/USD pair and assume that it goes from 1.1600 to 1.2100 with a volume of 20,000 and in the next session goes back from 1.2100 to 1.1600 with a volume of 15,000.Although the price remains the same, but since the up volume was more than the down volume, so the OBV line will be in an upward slope indicating the pressure on the Euro to rise and it will ultimately rise.
Uses of OBV
- To confirm price movements.
- To look for bullish or bearish divergences.
- OBV can act as a leading indicator if coupled with Moving averages and trend lines.
- It can be used in spotting breakouts. For e.g., if OBV is peaking up but price is going down, the probability of price going up as well is very strong.
Interpretation
- Since OBV changes precedes price change, so it can help in predicting the flow of smart money.
- If OBV is falling and price is increasing, then we can assume that sooner or later, the price will follow OBV as it does not have the strength to sustain a bull run for long.
- If OBV is going sideways with no successive highs or lows then it is regarded as a doubtful trend.
- If OBV is making new highs and new lows then it represents a bull run.
- If OBV is making lower lows and lower highs, then it can be regarded as a bear run.
- The trend remains intact unless it gets broken from falling to a rising trend or if the trend becomes doubtful for more than 3 days.