Let’s talk about on balance volume study (The OBV) in Thinkorswim (TOS). Joe Granville introduced the OBV in his 1963 book, Granville’s New Key to Stock Market Profits. It was one of the first indicators to measure positive and negative volume flow. The OBV is a study that was developed to point out when divergence occurred between price action and volume. Granville suggested in his book that moves in volume come before moves in price.
The on balance volume study finds a rising slope when volume from the up days is greater than the volume from the down days while the OBV finds a falling slope when volume from the down days is greater than volume from the up days.
Volume flow is a great way to identify money moving into a stock or out of a stock. Chartists can look for divergences between the on balance volume study and price to predict price movements or use the on balance volume to confirm price trends.
Granville noted that the on balance volume study would often move before prices. He discussed volume pressure in his book, suggesting that a rising on balance volume would signal buying pressure “pushing up” on prices that were flat or moving down and that a falling OBV would signal selling pressure “pushing down” on prices that are flat or moving upwards.
Using trend lines, these differences are easier to spot. With the OBV, volume is added or subtracted at the close of the candle so the trend lines should always be drawn against the close of the candle body, not against the wicks or the open of the candle.
These differences in direction are called divergence and before we go any further, we will look at the word divergence to get a better understanding of the meaning behind it. On Investopedia, there is a great definition of divergence. What is Divergence?
The divergence occurs when the stock price and volume move in opposite directions or when the price move is not as great as the volume on a chart. Divergence can be an indication of an imminent positive or negative price move. Divergence is one of the most complex signals and one that can give less experienced investors false signals.
The most common way to identify divergence with the on balance volume study is by using trendlines to distinguish when:
- the OBV is making a lower low (Steep Downslope) or higher low (Less Steep Downslope) while price action fails to make a the same
- the on balance volume is making a lower high (Low Volume) or higher high (High Volume) while price action fails to make the same
- price is making a lower low or higher low while on balance volume study fails to make the same
- price is making a lower high or higher high while OBV fails to make the same.
Here is an example of trend lines showing divergence between the OBV and price action.
Draw trend lines from the candle close, not from the candle wicks or candle open. Look at the on balance volume direction, not at the OBV number. Slope and direction are important, not the OBV total. Moves in volume come before moves in price. The on balance volume study should confirm price action or point out when to ignore the current price action.
How Do You Calculate On Balance Volume?
- Here’s how you calculate On Balance Volume:
- If the closing price is above the prior close price then:
- Current OBV = Previous OBV + Current Volume
- If the closing price is below the prior close price then:
- Current OBV = Previous OBV – Current Volume
- If the closing prices equals the prior close price then:
- Current OBV = Previous OBV (no change)
- The mathematical formula for the OBV study is basic addition or subtraction
Study and Specialization
On balance volume is a very simple indicator with very powerful signals but finding those signals can take some time. By adding a few changes to the regular OBV study found in TOS, we can identify when those signals are present and snap some trend lines onto the chart for confirmation.
http://tos.mx/4SKAro TOS link for my on balance volume study
Look at the changes made to the on balance volume study. First, I have added a Simple Moving Average to the OBV Study, to identify when the on balance volume is above or below average.
Next, I have added a red dot for bearish divergence and a green dot for bullish divergence. On the green candle highlighted below, the candle closed much higher than the previous candle close while the OBV signaled a very small volume gain.
This low volume confirmation signaled to the trader that new money was not supporting this higher move in price. I also have added labels and alerts which pop up when the OBV is giving signals a trader should pay attention to.
If the on balance volume crosses above or below the OBV Moving Average, or if there is Positive or Negative Divergence. As a final touch, I have added a change to price candles when there is a divergence between the on balance volume study and price action.
Recommendations: Once a divergence dot appears, snap a flat line onto the on balance volume study and the chart. Draw out trend lines looking for confirmation of the signal. Spotting divergence is difficult, even for experienced traders. The Red and Green Dots will help signal that something is ‘off’ and a second look should be given.
In the picture below, the OBV crosses below the Moving Average a few bars sooner than price crosses down below its moving average. Also, notice that the OBV continues to remain sloped down; staying below the moving average and giving no indication of a reversal.
While price action showed indecision and crosses above the moving average before crossing back below the average and moving lower. The OBV would keep a trader out of this trade, perhaps avoiding the price crossover signal.
The on balance volume study is a great technical tool to confirm volume and price for buying and selling pressure. This momentum indicator can be a great help when placing trades. It doesn’t matter if you are a day trader or a swing trader. The OBV indicator is extremely helpful.