On-Balance Volume (OBV)

On-Balance Volume (OBV) is a technical analysis tool used to forecast changes in the price of an asset by considering changes in volume. It is a composite indicator that calculates the accumulation of volume on up days and the subtraction of volume on down days to evaluate buying and selling pressure.

The OBV indicator was created by Joseph Granville, who believed that volume plays a crucial role in the functioning of financial markets and that price movements are largely influenced by volume. Granville argued that if the market volume of an asset experiences a significant increase, the price will eventually see a substantial spike, either upwards or downwards.

The calculation of OBV is relatively simple and depends on the closing price. When the price of an asset closes higher than the previous close, the volume for the 24-hour period is considered “up-volume.” Conversely, when the price of the asset closes lower than its previous close, the entire day’s volume is considered “down-volume.” OBV is only applicable to markets with exchange volume, similar to other volume-based indicators like the Klinger oscillator, money flow index, and negative volume index.

The OBV line is the key component of this indicator. The absolute value of OBV is not significant, but rather the trend and movements of the OBV line determine market trends. Analyzing OBV involves several steps:

1. Identify the trend by analyzing the OBV line.
2. Assess whether the current trend aligns with the trend for the underlying asset.
3. Identify support and resistance levels and mark them accordingly.
4. Observe OBV lines breaking their resistance levels, which can generate accurate signals to determine the upward or downward direction of the asset.

When looking for resistance breaks, it is essential to consider the closing prices as they play a crucial role in the OBV realm. However, it is important to note that the OBV indicator may become unreliable during periods of sharp volume spikes. In such cases, traders should wait for the settling period to be over to avoid false signals.

Additionally, divergence signals can help predict trend reversals in the bullish or bearish direction. These signals are based on the concept that volume precedes price, similar to OBV. A bearish divergence occurs when OBV goes down or closes lower than its previous low. On the other hand, a bullish divergence occurs when OBV rises and closes at a higher price than its previous close.

While OBV is a useful tool for analyzing market trends, it is important to note that it should not be solely relied upon for making trading decisions. Other technical indicators such as the Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), and Average Daily Volume (ADV) are also necessary for comprehensive analysis.

In conclusion, On-Balance Volume (OBV) is a valuable technical analysis tool that utilizes changes in volume to forecast price changes. By evaluating buying and selling pressure, OBV can help identify trends, support and resistance levels, and potential trend reversals. However, it is crucial to combine OBV with other indicators for a more comprehensive analysis of the market.