What Is an On-Balance Volume (OBV)?
On-Balance Volume (OBV) is a forecasting method used to predict price changes in an asset by considering volume dynamics.
It is a cumulative indicator that tracks the accumulation and distribution of volume to assess buying and selling pressure.
On-Balance Volume (OBV) | Source: Investopedia
Understanding OBV Principle
According to the OBV principle, if an asset’s price closes higher than the previous close, the 24-hour volume is considered “up-volume.”
Conversely, if the asset’s price closes lower than its previous close, the entire day’s volume is regarded as “down-volume.”
OBV operates on markets with exchange volume, similar to other volume-based indicators like the Klinger oscillator, money flow index, and negative volume index.
Joseph Granville’s Insight
Joseph Granville, the founder of On-Balance Volume (OBV), believed that volume plays a crucial role in how financial markets function and that price movements are largely influenced by volume.
Granville proposed that if an asset’s market volume experiences a significant increase, the price will eventually see a substantial spike, either upward or downward.
Understanding Trends and Resistance
It’s important to note that the absolute value of OBV is not significant; rather, the OBV line determines market trends.
The steps to analyze OBV and its trends are as follows:
- Define the trend for OBV.
- Determine if the current trend aligns with the trend of the underlying asset.
- Identify and mark support and resistance levels accurately.
- When the OBV lines break their resistance levels, accurate signals can indicate the upward or downward direction of the asset.
When looking for resistance breaks, consider the closing prices, which play a significant role in OBV.
However, the OBV indicator may become unreliable during sharp volume spikes. In such cases, waiting for the settling period is advisable, allowing the market to stabilize.
Using Divergence Signals
Divergence signals can predict trend reversals in either 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 declines or closes lower than its previous low, while a bullish divergence forms when OBV rises and closes at a higher price than its previous close.
It’s important to note that OBV alone cannot predict bullish and bearish trends in the market. Technical indicators such as MACD, RSI, and ADV are also necessary for comprehensive analysis.