Weekly Insights: Using OBV to Your Trading Advantage
Using OBV to Your Trading Advantage
Continuing with the theme of secondary trading tools, another one from my personal trading toolbox is the ‘on balance volume’ indicator (OBV), developed by the respected stock market trader and analyst Joe Granville.
OBV is calculated as the continuous consecutive sum of volumes, whereby the entire volume of a day is added to the volume of the previous trading session’s OBV if today’s closing price is above that of the previous session. Should the closing price be below that of the previous session, the day’s volume is subtracted. Unchanged closing prices have no effect on the OBV–the volume is neither added nor subtracted.
The OBV study indicates whether money is flowing into or out of a market. Based on Granville’s principle, changing trends in the price of the underlying market are anticipated by trend changes in the OBV indicator. The theory is that one can see the flow of “smart money” into a market by an increase in the OBV. As soon as the public moves into the market, both the market and the OBV will surge ahead.
The OBV indicator shows an upward trend whenever a new high or low exceeds the previous one. In the opposite case, a lower high or low indicates a downtrend. The change in the OBV from an upward to a downward trend is called a breakout.
Importantly, in the OBV analysis, it is assumed that OBV breakouts precede the market breakouts, with very little time for a trader to react. This study is not a timing tool. Rather, it monitors market sentiment, and it can alert you to a changing market situation. This alert may be used as a signal to taking a long position on upside breakouts and selling short when the OBV makes a downside breakout. Traders usually hold the position until the trend changes.
Once a trend has been established, it remains until it is broken. This happens when a downward trend changes to an upward trend and vice versa, or when a trend changes to a choppy, sideways movement for more than three days. If a market changes from an uptrend to a sideways trend and remains non-trending for two days only and then reverses to an uptrend again, the market is considered to be in an uptrend as before.
It should be noted that the OBV indicator does not work on intra-day charts.
Granville has a book, “The New Commodity Trading Systems and Methods” that provides further details on this and other indicators.
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