When the trend of the OBV is identical to the trend of price movements, then this trend is considered strong. If, however, the OBV trend diverges from the trend of the instrument, this might be a sign that the trend is unstable.
Chart Types: Not applicable for Intraday or Tick Charts
Calculation
The On Balance Volume indicator, developed by Joe Granville, is calculated as the continuous consecutive sum of volumes, whereby the entire volume of a day is added to the volume of the previous day’s OBV, if today’s closing price is above that of yesterday. Should the closing price be below that of the previous day, the day’s volume is subtracted. Unchanged closing prices have no effect on the OBV – the volume is neither added nor subtracted.
Formula
Ct > Ct-1 --> OBVt = OBVt-1 + Vt
Ct < Ct-1 --> OBVt = OBVt-1 - Vt
Ct = Ct-1 --> OBVt = OBVt-1
OBV = On balance volume
V = Volume
Interpretation
The OBV shows in a simple manner whether capital is flowing into or out of a market and/or instrument. Based on Granville’s principle, changing trends in the price of the underlying instrument are anticipated by trend changes in the OBV. The theory is that you can see the flow of smart money into an instrument by an increase in the OBV. As soon as the public moves into the instrument, both the instrument and the OBV will surge ahead.
The OBV shows an upward trend whenever a new high or low exceeds the previous one. In the reverse case, a lower high or low indicates a downtrend. The changing in the OBV from an upward to a downward trend is called a breakout. In the OBV analysis, it is started from the assumption that OBV breakouts precede the instrument breakouts, but that there is very little time to act. This study is not a timing tool. Rather, it monitors market sentiment for you, and it can alert you to a changing 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. Investors 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 an instrument 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 being in an uptrend as before.
The On Balance Volume indicator is not currently applicable for Intraday charts and will never be applicable for Tick charts, due to the nature of the data.
Literature
§ Granville, Joseph J. The New Commodity Trading Systems and Methods.
§ Granville, Joseph J. Granville’s New Key to Stock Market Profits.
§ Colby, Robert F., Myers, Thomas. A. The Encyclopedia of Technical Market Indicators. Dow Jones – Irwin. Homewood, IL. 1988.
§ Kaufman, Perry J. The New Commodity Trading System and Methods. 1987.