Hello, dear friends. Everyone who trades in the financial
markets wants to be successful. It is a little difficult to get a high return
by investing a small capital, but it is not impossible. As long as we can predict the direction
of prices by making the right analysis. In this field, there are many technical
analysis tools that can assist us. We can especially add technical indicators
to this tool set. Technical indicators are an indispensable market analysis
tool for almost all traders trading in the financial markets from around the
world. Today, we will discuss one of these market analysis tools, the On-Balance
Volume (OBV) indicator.
What is the On-Balance Volume indicator?
On-Balance Volume (OBV) is a volume-based indicator used in
technical analysis. It evaluates price changes and volume together by showing
the relationship between price movements and trading volume in financial
markets. The On-Balance Volume (OBV) indicator was developed by American
technical analyst and financial author Joseph Granville. He introduced and
popularized this indicator in his 1963 book, 'Granville's New Key to Stock
Market Profits.' This indicator is mainly used to analyze the price movements
of stocks, currencies, commodities, and other financial assets. The OBV
indicator has gained broad acceptance in financial markets as a tool to
determine whether an asset's price is rising or falling based on the volume of
trades that occurred on a given day. The fundamental concept behind this
indicator is as follows: If an asset rises with increasing trading volume, it
suggests that the price increase is strong and sustainable. Conversely, if
prices rise with declining trading volume, it may be a sign of weakness. As a
result, the OBV indicator allows us to use trading volume to understand an
asset's price movements. It also helps us better comprehend buying and selling pressure
and price trends.
Calculation of the On-Balance Volume indicator
The On-Balance Volume (OBV) indicator is constructed by
evaluating price changes and volume together. To calculate this indicator,
initially, the OBV (previous day) value is considered as zero, or a starting
point is established. Then, for each new trading day, the daily OBV value is
calculated based on the trading volume and direction, and it is added to the
previous day's OBV value. The OBV value increases, decreases, or remains
unchanged based on the trading direction. The resulting daily OBV values are
plotted on a chart, and changes over time are monitored. This chart helps in
identifying accumulation or distribution periods for an asset. The formula used
to calculate the On-Balance Volume (OBV) indicator is as follows:
OBV = OBV(previous day) + (Trading Volume (today) × Trading
Direction)
Here:
- OBV represents the daily On-Balance Volume value.
- OBV(previous day) represents the OBV value from the previous trading day.
- Trading Volume (today) represents the daily trading volume.
- Trading Direction is indicated by a sign that shows whether prices increased or decreased: When prices rise, Trading Direction is +1. When prices fall, Trading Direction is -1. When prices remain the same, Trading Direction is 0.
Thus calculated, the On-Balance Volume (OBV) measures the
relationship between trading volume and price movements. This allows us to
identify accumulation or distribution periods for an asset. An increase in OBV
can indicate that an asset is being accumulated or gathered by buyers, which
suggests a tendency for prices to rise. On the other hand, a decrease in OBV
can indicate that an asset is being distributed or sold by sellers, indicating
a tendency for prices to fall.
Using the On-Balance Volume (OBV) Indicator to Trade
Trading in financial markets, technical indicators are
generally known for producing delayed signals, which is considered a
disadvantage. However, not all indicators are lagging indicators. The
On-Balance Volume (OBV) indicator can be added to the list of leading
indicators. The fact that the On-Balance Volume (OBV) indicator acts before
prices is a major advantage. We will now look at a live example of this. We can
make buy-sell decisions using several methods with the On-Balance Volume (OBV)
indicator. One of the most commonly known methods is trading using the trend
line. We can follow the OBV indicator to confirm the continuation of a trend.
The OBV indicator can provide a strong signal for the trend's continuation. For
example, if the price is rising and OBV is also rising, there is a possibility
that the uptrend will continue. In this case, we can place a BUY order.
Conversely, if the price is falling and OBV is also falling, it is expected
that the downtrend will continue. In this case, we can place a SELL order.
Besides that, we can also follow the OBV indicator for a trend reversal. The
OBV indicator can provide a strong signal for a trend reversal as well. For
example, if the price is rising but OBV is falling, there is a high probability
of a trend reversal. In this case, we can place a SELL order. If the price is
falling, but OBV is rising, there is also a possibility of a trend reversal. In
this case, you can place a BUY order. Now let's look at live examples of
these. In the 1-hour chart of the New Zealand Dollar/US Dollar below, during an
uptrend, the indicator breaks down the support level before the price,
signaling the beginning of a trend reversal. The OBV indicator acting before
the price breakdown provides us with a signal to enter a SELL order. Similarly,
in the same chart, during a downtrend, the indicator breaks above the
resistance level before the price, signaling an early breakout and providing us
with a signal to enter a BUY order:
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| OBV trading with breakout and breakdown in NZD/USD chart |
We can trade with all types of divergences in the On-Balance
Volume (OBV) indicator, just like with other technical indicators. Below is a
live trading example on a 4-hour chart of the Australian Dollar/US Dollar,
demonstrating both positive (bullish) and negative (bearish) divergence types.
When trading in the Forex market, if we come across positive (bullish)
divergence, we enter a BUY order, and if we encounter negative (bearish)
divergence, we enter a SELL order. In this example, we are not only showcasing
a trading strategy with just two divergence types, but also calling attention
to the fact that we can use all divergence types with the On-Balance Volume
(OBV) indicator in trading.
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| Trading Divergence with the OBV Indicator in the AUD/USD chart |
Some traders add a moving average to the On-Balance Volume
(OBV) indicator with settings suitable for their strategies, such as 10
periods, 20 periods, 50 periods, and so on. If the On-Balance Volume (OBV)
indicator line (in the example chart below, the blue line) crosses the moving average (pink line) from below to above, they enter a long position. Otherwise,
if the indicator line (blue line) crosses the moving average (pink line) from
above to below, they open a short position. In the 4-hour chart of Spot Gold/US
Dollar below, a 50-period Simple Moving Average (SMA) has been added to the
On-Balance Volume (OBV) indicator, and an example trade is shown.
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| Trading with the OBV and MA in the XAU/USD chart |
Keep in mind. The Forex market is a global and volatile
market where prices can rapidly rise and fall. When trading here, prices can
change quickly, leading technical indicators to produce incorrect signals. Like
any technical indicator, the On-Balance Volume (OBV) indicator can also make
errors. Therefore, when using the OBV indicator, one should be cautious and not
rely on it alone. The OBV indicator can provide more accurate signals when used
in conjunction with other technical indicators. Good luck with your trades!