On Balance Volume

Volume is often a misunderstood and/or underestimated piece of trading data that can provide useful insight into the behaviour of market participants. It can demonstrate the commitment of buyers and sellers and provide further evidence of other analysis you are conducting.

For example, in order to validate a trend or a particular pattern you may identify, an indication of relatively strong volume would add further evidence and strengthen your reasons for buying. The term ‘relatively strong volume’ is used because you may compare the volume in a company to its average daily or weekly volume in the recent past. Consequently, if you see a significant increase in volume supporting the present move in the share price, that would add weight to the pattern you have identified.

On Balance Volume or OBV is a momentum indicator that relates directly to volume, and can provide some insight into the commitment of buyers and sellers. OBV is basically a running total of volume as it effectively depicts the volume moving in and out of a security.

Its calculation is quite simple. When a security’s price closes higher than the previous close, it adds the volume for the day to the OBV total. If a security’s price closes lower than the previous close, it subtracts the volume.

The primary premise behind OBV is that it can detect when large amounts of money are moving in or out of a security. Trends can be analysed in OBV just like they can with share prices. Therefore, the OBV is in an up trend when each new peak is higher than the previous peak and each new trough is higher than the previous trough. Similarly, the OBV is in a down trend when each successive peak is lower than the previous peak and each successive trough is lower than the previous trough.

Another basis for using OBV is that if the share price movement precedes OBV movement, a ‘non-confirmation’ has occurred. This is important when you consider that volume is an effective confirmation tool. This means that while you may be observing a bullish pattern forming in the chart, it may not be confirmed by a rising OBV. In fact, the OBV may be falling over the recent period indicating that the down days in that bullish pattern are supported by relatively strong volume compared to the up days.

The direction of OBV can be used as a final check before a possible entry. If you receive a buy signal, however over the last week or so, OBV has been declining, it may be worth holding off your entry until the volume increases and supports the movement in the share price, or not taking the trade at all. This little check before entry may result in you having fewer losing trades.