On-Balance Volume (OBV) is a technical trading momentum indicator that utilizes volume flow to forecast changes in stock prices. It was first developed by Joseph Granville, who emphasized the importance of volume in predicting market movements. When volume increases sharply without a significant price change, it often indicates an imminent price adjustment.
Key Takeaways
- Momentum Indicator: OBV leverages volume changes to make price predictions, revealing crowd sentiment that can precede a bullish or bearish outcome.
- Differentiating Factors: OBV provides more actionable signals than general volume histograms by comparing price bars and volume action.
Formula for On-Balance Volume (OBV)
The calculation of OBV follows these rules:
OBV = OBV_prev + {
volume, if close > close_prev
0, if close = close_prev
-volume, if close < close_prev
}
where:
OBV= Current OBV levelOBV_prev= Previous OBV levelvolume= Latest trading volume amount
Understanding OBV’s Implications
OBV hinges on tracking the volume differences caused by smart money (institutional investors) and retail investors. When large investors buy while retail investors sell, volume often rises, pushing the price upwards. Analysts rather focus on the slope and movement trend of the OBV line more than the absolute numerical value.
Practical Example of OBV Application
Here’s how you would calculate OBV over ten days to track changes:
- Day 1:
- Closing Price: $10
- Volume: 25,200 shares
- OBV: 0
- Day 2:
- Closing Price: $10.15
- Volume: 30,000 shares
- OBV: 0 + 30,000 = 30,000
Detailed calculations: (Up-days: 2, 3, 6, 7, 9; Down-days: 4, 5, 10; No-change days: 8)
- Day 10: OBV: 99,600 - 27,500 = 72,100
Differentiating OBV from Accumulation/Distribution
While OBV adds or subtracts total daily volume from the cumulative total based on price movement, the Accumulation/Distribution Line takes into account where the current price stands within the day’s price range.
Alternative: Volume-Price Trend (VPT)
VPT adds another layer by considering the degree to which the closing price differs from the previous close. This provides more granular insight into price direction and momentum.
Overcoming OBV’s Limitations
Despite OBV being a leading indicator, it can produce false signals. Balanced use with lagging indicators, like moving averages, may yield more effective predictions. Be cautious of single-day high volume spikes due to unique events that can distort results.
The Fundamentals of Average Daily Trading Volume (ADTV)
ADTV signifies the average number of shares traded daily for a given stock. This metric aids traders in assessing liquidity and volatility, optimizing trade execution, and managing risks. When used with OBV, ADTV enhances market activity evaluations.
Bottom Line
On-Balance Volume (OBV) is an essential tool for analyzing market volume flow and guiding trading decisions. Its real strength lies in tracking market sentiment and its potential for price shifts, which, although predictive, should be used judiciously alongside other indicators to mitigate false signals.
Related Terms: Volume-Price Trend, Accumulation/Distribution Line, Average Daily Trading Volume.
References
- Joseph E. Granville. Granville’s New Key to Stock Market Profits. Papamoa Press, 2018.
