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Article by dailystock_admin    (04-27-09 11:01 AM)
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What is the On-Balance-Volume Indicator?

On balance volume is a method used in technical analysis to detect momentum. It is calculated by measuring the volume of a stock to its price change. It provides a running total of volume and shows whether the volume is flowing in or out of a given security. OBV is calculated by adding the day's volume to a running cumulative total when the security's price closes up, and subtracts the volume when it closes down. It is the trend of the OBV line that is important, not the actual numbers themselves. OBV is a momentum indicator that helps quantify buying or selling pressure. OBV changes often precede price changes in the stock prices.

This indicator was initially developed by Joe Granville. Granville is probably best known for his bearish market calls during the 1970s, 1980s, and 1990s, when he claimed that the stock market was headed for imminent collapse. But a stopped clock is correct twice a day and according to the the Hulbert Financial Digest, his timing record is very poor. Nevertheless, some technicians swear by this indicator. Granville introduced the On Balance Volume (OBV) indicator in his 1963 book, “Granville's New Key to Stock Market Profits”. This was one of the first and most popular indicators to measure positive and negative volume flow. The concept behind the indicator was that the volume precedes the change in prices of a stock . It is a simple indicator that adds a period's volume when the close is up and subtracts the period's volume when the close is down. A cumulative total of the volume additions and subtractions forms the OBV line. To look for divergences or confirmation, OBV line can be compared with the price chart of the underlying security.




On Balance Volume theory can act as a leading indicator to predict upcoming price changes in any stock. Trend line analysis proves very useful for this purpose. OBV gives direction to the volume indicator, and helps a trader to check if there is buying tendency or selling pressure on the stock, and whether the price chart is conforming to that pressure. OBV can help identify trends that can be traded, a change of sentiment by investors, It also indicates divergences in which price is heading opposite to the prevailing buying or selling pressure. Since OBV is one of the most basic indicators to enhance the regular volume indicator, it is recommended that a trader should learn or at least have an proper understanding of its workings in order to trade better. It is very helpful to a trader.


On Balance Volume is normally used to either confirm price movements or check whether they are looking bearish or bullish at a point of time. Alternatively, it could also be used by swing traders using trendlines and moving day averages to predict changes in short term term trades. OBV can also help spot breakouts. If OBV breaks to new high, but price is below previous high, probability is that prices will follow.

Disadvantages of OBV

Firstly, it does not work on intra day chart. Secondly, volume has become less reliable an indicator with the developments of program trading, ETFs, index funds, quantitative trading funds that buy and sell baskets of assets within seconds.

References

Larry Williams, Letters to Technical Analysis of Stocks and Commodities magazine
Joseph E. Granville, “Granville's New Strategy of Daily Stock Market Timing for Maximum Profit.”


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