On Balance Volume

On Balance Volume

4 min read

The (OBV) on balance volume is a momentum trading indicator. It predicts changes in a stocks price using volume flow. OBV measures both the buying and selling pressure and uses an indicator that adds up a stocks volume on bullish days and subtracts volume on bearish days. When price action closes above previous days close, all of the trading volume that day is considered up-volume.

On Balance Volume aka OBV is a popular trading indicator. It is a momentum trading indicator. It uses volume to predict changes in price. It’s used as a guide to smooth out a volume trend and identify when more or less volume is flowing into the stock. It’s easier to read than volume bars.

This battle affects stock prices. Sometimes volume comes in without price changing. Hence the invention of the on balance volume indicator. Volume has always played an important role in trading.

A man by the name of Joseph Granville invented the OBV in the sixties. He saw the need for an indicator that matched volume with price. His development showed that if volume jumps before price, price tends to follow.

On balance volume is based on institutional investors and less experienced retail traders. Many of us would be considered the less experienced retail traders while institutional investors are large companies.

The on balance volume indicator measures positive and negative flow. Positive flow is considered bullish because price has continually closed higher.

While the negative flow is bearish. Meaning price has continued to close lower. The OBV is basically the sum of the two over a period of time. In other words, OBV is math.

For example, if today’s closing price is higher than yesterdays then the most up to date OBV would be the previous OBV + today’s volume. If today’s closing is lower than yesterdays, the OBV would be the previous on balance volume – today’s volume.

If today’s closing price was equal to yesterdays than the on balance volume stays the same.

Breaking Down the Theory

The creator of on balance volume believed that volume proceeded price. If the OBV is trending higher, traders conclude that price is going to rise. A rising OBV reflects positivity. Positive volume can lead to higher prices.

The opposite is also true. An OBV that is trending down shows negative volume. This signals lowering prices. This indicator can be useful near the end of a trend when price hasn’t changed but volume has.

First, find the trend on the OBV. Second, does trend of the OBV match the current trend of the stock? Third, look for support and resistance. Support and resistance are crucial in trading.

Once support or resistance is broken, the OBV will change. This is a signal to either go long or short. It’s important to remember that spikes in volume can throw off the on balance volume indicator.

Trend Confirmation

The saying “the trend is your friend” is a common saying when stock market trading. It’s completely true as well. Being able to draw trend lines is an important skill to develop. 

If you’re day trading it’s possible to use bollinger bands as trend lines. They’re just not the straight angular lines known as trend lines.

Trend trading is useful for all styles of trading. The on balance volume indicator is another tool you can use to confirm the trend. You can also use RSI and candlestick patterns. It’s important to use other forms of technical analysis for trend confirmation along with on balance volume.

Using Other Indicators and Pattern Confirmation

It’s smart to pair other technical indicators with the OBV. No indicator is able to stand alone. Using moving averages and VWAP or RSI and MACD are needed.

You may even hear other traders say you don’t need any technical analysis. However, indicators are tools used to confirm moves. Trading can be and is emotional.

Technical indicators take the emotion out of a trade. As a result, you can protect your profits and keep your losses to a minimum.

Patterns are a huge part of trading. They can be reversal patterns or continuation patterns. Patterns coupled with the OBV can give extra confirmation to trends as well as changes in trends.

That means you have to spend the time and put in the effort to learn chart patterns. As a result, you’ll become an excellent trader. Being the best trader you can be should be the ultimate goal.

On balance volume is a tool that uses volume along with price to find buying and selling pressure. Like with any indicator, practice using it before placing live trades based off what an indicator is telling you.

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