4 secrets to incorporating On-Balance-Volume (OBV)

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24 Nov 2023

A widespread tool for gauging buying or selling pressure in the market is the on-balance volume indicator, which market analyst Joe Granville developed in 1963. It utilizes cumulative volume to provide insights into the flow of volume, making it one of the pioneering indicators. Granville initially introduced the indicator in his publication New Key to Stock Market Profits, which underwent a reprint in 2010.

Granville, who thought that volume could signal an impending trend shift or a significant movement in the market, developed the On-Balance-Volume (OBV) indicator. The term "smart money indicator" is commonly used to describe this phenomenon, as it unveils the activities of prominent financial market participants before the general public's knowledge of such actions. Using volume as a primary indicator by Granville has proven beneficial for traders in predicting market fluctuations and enabling them to make well-informed choices.

In one of our previous articles, we considered the on-balance volume indicator for Metatrader. In this article, we will share four secrets of On-Balance-Volume (OBV) implementation in your trading system. You will learn how to research forex on balance volume.

Definition of the On-Balance Volume

What is on balance? Let's see.

The On-Balance Volume indicator is a momentum indicator that calculates momentum based on the flow of volume. Analysts can utilize the indicator as a means of forecasting significant fluctuations in the price of an asset. Finding OBV indicator anomalies that do not correspond to the observed price movement is the way to accomplish this.

In the book published in 1963, the introduction of the indicator marked a significant milestone. The author of the book, Joe Granville, also the indicator's creator, provided a detailed explanation of the signals generated by the obv on-balance volume indicator. He likened these signals to a "spring" that could propel the price sharply and decisively, either towards one direction or the other.

The Importance of Utilising the On-Balance Volume Indicator

How to use on balance volume? The idea that volume comes before price persuaded the person who developed the indicator. Thus, the OBV indicator was devised to indicate instances when volume experiences a significant surge without causing any asset price movement. This suggests that institutional investors and other knowledgeable investors are strategically establishing positions in anticipation of a substantial shift in market sentiment.

The On-Balance-Volume (OBV) indicator can anticipate price movements in advance when used with trendlines. The tool is compatible with various trading technical analysis indicators, including the 200-day moving average, which can provide additional confirmation for entering ultra-safe positions. When implementing appropriate tactics, a trader has the potential to maximize their profits from the market while simultaneously minimising risk to the lowest possible level.

What the On-Balance Volume Indicator Does and How It Works

The On-Balance Volume indicator shows the cumulative volume, both positive and negative, indicating the money flow into or out of a stock, forex, or crypto asset. Due to volume picking up before price movement on stock charts, it is regarded as a leading indicator.

However, being a leading indicator, one of its most significant limitations is the false positives it produces. Including trend lines or moving averages with the OBV indicator is recommended for traders to maximize profit potential and manage risk effectively during technical analysis. A successful combination can be achieved by waiting for additional signals to validate the OBV indicator signals.

How to Figure Out On-Balance Volume

To compute the On-Balance Volume (OBV), it is necessary to aggregate the volume of a given security for a specific day if the market concludes with a price increase. Conversely, if the day's closing price decreases, it becomes necessary to deduct the day's volume from the previous day's OBV of the asset.

The subsequent equations represent the calculations for on-balance volume:

If today's closing price is greater than the closing price of the previous day, the on-balance volume is calculated by adding the OBV from the last day to the current day's trading volume.

In the scenario where today's closing price is equal to the closing price of the previous day, The OBV (On-Balance Volume) on the last day is similar to the OBV on the previous day + 0.

If the closing price of today is lower than the closing price of the previous day, on balance volume formula will be: OBV = OBV on the last – today's trading volumes.

Advantages of Trading with the On-Balance Volume

The subsequent aspects will expound on the benefits of utilising OBV in trading:

  • One of the main advantages of utilising OBV is that it enables retail investors to monitor the activities of institutional investors. This concerns the capital that institutional investors like banks, investment funds, retirement funds, and similar organisations allocate. The magnitude of these investments significantly impacts financial markets, providing small investors with opportunities for leverage.
  • The magnitude of volume plays a significant role in driving significant shifts in the market. In situations where stock prices exhibit minimal fluctuations and a considerable surge or decline in trading volume, a notable price shift may likely occur. By understanding the potential fluctuations in volume, individuals can anticipate likely bullish or bearish sentiments.
  • The on-balance volume (OBV) is a straightforward tool that allows traders to generate distinct trading signals by calculating the cumulative volume of upward and downward movements. Creating a continuous line that displays all the peaks, valleys, and trend patterns resembling price bars is possible. Comparing the On-Balance-Volume (OBV) indicator to price bars can give users more precise signals.
  • The OBV indicator proves to be an excellent tool when employed during significant market peaks or troughs. Investors can utilize this tool to assess potential breakouts and breakdowns in the price of an asset. As an illustration, a bullish divergence has the potential to indicate that a price rally is likely to surpass a resistance level.

On-balance Volume Indicator Drawbacks

There are certain drawbacks associated with utilising OBV as a trading indicator:

  • Although OBV is considered a reliable leading indicator, it cannot provide comprehensive insights into the broader context of the signals it generates. As a result of this factor, there is a possibility of misinterpretations and inaccurate positive outcomes, potentially resulting in financial losses.
  • One drawback of on-balance volume is its susceptibility to significant fluctuations in value due to a substantial market movement occurring within a single day. Consequently, the inclusion or exclusion of a stock from an index can temporarily disrupt this indicator's accuracy, resulting in a significant surge in trading volume.
  • The trading indicator may not be ideal for day traders due to its lacklustre performance when an asset's price remains stagnant within a specific range.

On-balance Volume Indicator: How to Use?

Verifying the on-balance volume is straightforward since most trading platforms include this feature as a built-in function. It is crucial to bear in mind that the effectiveness of the OBV chart is observed when the asset's price exhibits both upward and downward movements. The suitability of these charts may be compromised when there are frequent fluctuations in price trends or when the markets are experiencing consolidation.

It is essential to verify if the timeline of the OBV indicator aligns with the timeline of the price charts on specific platforms. When examining a day-to-day price chart, it is advisable to refrain from choosing the weekly On-Balance-Volume (OBV) indicator.

Understanding the precise numerical value of OBV is optional for its interpretation. Applying it to price charts lets you unlock its full potential. The on-balance volume indicator is known for its reliable performance when combined with other indicators like the relative strength index and moving averages.

4 Secrets for Optimising Your Trading Strategy with OBV

Integrating On-Balance-Volume (OBV) into an on-balance volume trading strategy can be an influential asset, aiding in identifying potential trends and market sentiment. When examining the volume of a specific asset, the On-Balance-Volume (OBV) indicator can provide valuable information regarding the dominance of buyers or sellers. This insight can be highly beneficial when making trading choices. Although there are differing opinions on the reliability of volume analysis as an indicator of price movements, numerous traders have reported positive outcomes by integrating the On-Balance-Volume (OBV) into their trading strategies.

Below are a few key points to keep in mind when integrating OBV (On-Balance Volume) into your trading approach:

  1. Obviously, it is evident that On-Balance-Volume (OBV) can serve as a valuable instrument in recognising trading patterns and trends. One of the critical advantages of utilising OBV is its ability to assist in recognising market trends. By examining an asset's volume over a specific period, the On-Balance-Volume (OBV) indicator can assist in assessing the market's inclination toward bullish or bearish trends. If the OBV line exhibits an upward trend simultaneously with the asset's price experiencing an increase, it could suggest a robust bullish trend;
  2. One advantage of utilising OBV is its ability to validate price fluctuations. If the value of a particular asset is on the rise while the OBV line is showing a downward trend, it could suggest that the surge in price lacks substantial buying volume and might be poised for a corrective decline;
  3. One helpful tool for identifying divergences is the OBV indicator. Divergences manifest when the value of a financial instrument undergoes a shift in one direction while the On-Balance-Volume (OBV) line experiences a contrary movement. This observation may suggest a possible change in direction, which could serve as a valuable indicator for traders. If the value of a particular asset is on the rise while the OBV line is showing a downward trend, it could suggest that the surge in price lacks substantial buying volume and might be poised for a corrective decline;
  4. The utilisation of OBV can be enhanced by combining it with other indicators: Although OBV is a potent tool by itself, it can be further strengthened by incorporating it with other indicators, resulting in a more comprehensive analysis. As an illustration, specific traders might employ the On-Balance-Volume (OBV) indicator in conjunction with moving averages to detect possible shifts in market trends.

Utilising OBV in your trading approach can be valuable in recognising patterns, validating price shifts, and pinpointing possible reversals. Although it may not be infallible, numerous traders have achieved favourable outcomes by incorporating the On-Balance-Volume (OBV) indicator alongside other indicators to facilitate well-informed trading judgments. You can acquire a distinct advantage in the market by dedicating sufficient time to comprehend the mechanics of OBV and its potential applications within your trading strategy.

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