OBV – On Balance Volume Helps Makes Sense of Stock Trading Volume

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OBV – On Balance Volume – can frequently warn of sharp moves in stock prices.

Sharp moves – or even moves against the overall trend of stock prices frequently take many stock investors by complete surprise.  A valuable indicator that can be used to detect that a change might be underway is the On Balance Volume indicator.

OBV can provide an assessment of the cumulative volume action on stock prices that can be difficult – or impossible – to ascertain by observing daily trade volumes on a stock chart.

This doesn’t mean that OBV can predict changes 100% of the time but it does provide some early warning that changes in price action is likely – especially when combined with other indicators used in our profitable investing strategy.

This article will explore how the OBV indicator is constructed, and how to use it to monitor trading signals.

On-Balance-Volume-OBV

On Balance Volume construction

OBV measures buying and selling pressure – which is our prime objective in technical stock analysis –  by adding the trading volume on increasing price days and subtracting the trading volume on decreasing price days.

The following equations are used to calculate the OBV for any stock trading period:

If the closing price is above the prior period close then Current OBV = Previous OBV + the current period volume
If the closing price is below the prior period close then Current OBV = Previous OBV – the current period volume
If the closing price is the same as the prior period close then Current OBV = Previous OBV

The result of these calculations on an ongoing basis is a number that does not relate to a specific scale and indeed the number will change depending on the length of time, or time period over which it’s calculated.

What profitable investing looks for in the OBV is support of the ongoing stock price trend and the occurrence of a bearish divergence in an up trending stock, and a bullish divergence in a down trending stock.

OBV Up Trend Confirmation and Bearish Divergence

OBV – On Balance Volume – Bearish Divergence

The accompanying chart is a simplified drawing of a stock price and the OBV showing a trend

confirmation signal that suddenly turns bearish prior to the stock trend changing.

This is exactly what the OBV is used for.

Up until point A in the chart the stock trend has been making higher highs and higher lows, just like a stock in an uptrend would be expected to do.  The trading volume driven OBV has also been creating higher highs and higher lows.  This reflects the situation that the volume of buyers and sellers are supporting the price trend.

Suddenly, at point A shown on the chart, the stock price and the OBV line diverge.  The stock price has made a higher high, but the OBV  has not.  Also, the OBV has fallen dramatically to a level lower than the last several stock price pullback lows.

This situation is referred to as a bearish divergence and casts immediate doubt onto how long the increasing price trend will continue.  Frequently you’ll find that this type of divergence presages a change in price trend – often a sharp move down that initiates a new price down trend.

As soon as you recognize an OBV bearish divergence from the stock price has occurred you should immediately consider moving stops up to capture profits or minimize losses.

OBV DownTrend Confirmation and Bullish Divergence

OBV – On Balance Volume – Bullish Divergence

The second chart is a simplified drawing of a stock price and the OBV showing a trend confirmation signal that suddenly turns bullish prior to the stock trend changing.

This again is exactly what the OBV is used for.

Up until point B in the chart the stock trend has been making lower highs and lower lows, just like a downtrend should.  The trading volume driven OBV has also been creating lower highs and lower lows.  This reflects the situation that the volume of buyers and sellers are supporting the price trend.

Suddenly, at point B shown on the chart, the stock price and the OBV line diverge.  The stock price has made a lower low, but the OBV has not.  Also, the OBV has risen dramatically to a brand new high level above than the last several stock price pullback highs.

This situation is referred to as a bullish divergence and casts immediate doubt onto how long the decreasing price trend will continue.  Frequently you’ll find that this type of divergence presages a change in price trend – often a sharp move up that initiates a increasing price trend.

As soon as you recognize an OBV bullish divergence from the stock price has occurred you should immediately add this stock to your watch list and review regularly for other indications that a new long position should be entered.

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