By: Terry Allen
Joseph E. Granville developed his On-Balance Volume indicator (OBV) in 1962 and published his entire OBV theory in his book: ‘How to read the Stock Market’. The OBV is one of the most famous momentum indicators and utilizes the relationship between volume, price and momentum of any stock. In Forex terms, the OBV compares the volume flows and price for any currency pair over a selected time-period.
Basically, if the price of a currency pair achieves a higher daily close than its previous reading, then the OBV considers all the day’s volume as up-volume. However, should price finish the day with a lower value, then the day’s volume is considered down-volume. The OBV line is then formed from the cumulative total of the positive and negative volume flows.
Granville’s research demonstrated that when the OBV readings changed direction then this action forecasted a possible price reversal. For example, if a currency pair started to climb, then this would force the OBV higher which would drag price with it. You can use the OBV to detect new trends. For instance, if OBV started to display a series of higher peaks and troughs, then you should consider a long trade with your currency pair of interest. In contrast, if OBV begins to post a sequence of lower tops and dips, then you should consider this as a very strong sell signal.
As the OBV concentrates on the trends of currency pairs, you can detect any new trading opportunities emerging if it starts to diverge. Granville stated that if volume was beginning to drop within a bull channel, then buying pressure was beginning to wane. As such, you should not expect the bull action to be sustained for much longer and a price reversal could be imminent. He also advised the same about bear channels. Granville recommended using a 20 period moving average together with his OBV to help confirm that trends were beginning to weaken. You will be able to detect these events more easily by noting any crossovers of the OBV line and its moving average. The OBV is regarded as one of the most simple and popular momentum indicators and you should best use it as follows.
Any OBV and price divergence forecasts that a possible price reversal is imminent. If price and OBV are tracking each other and then OBV changes direction, then this is a good sign of a new trading opportunity. You should confirm these events by checking for any crossovers of the OBV and its moving average. For example, if price and OBV are both bearish but OBV turns bullish, then this is a good buy signal.