Monday, October 31, 2011

On Balance Volume (OBV)

Joe 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: volume precedes price. OBV 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. This line can then be compared with the price chart of the underlying security to look for divergences or confirmation.


As stated above, 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.
For example, if today the closing price is greater than yesterday's closing price, then the new
OBV = Yesterday's OBV + Today's Volume
If today the closing price is less than yesterday's closing price, then the new
OBV = Yesterday's OBV - Today's Volume
If today the closing price is equal to yesterday's closing price, then the new
OBV = Yesterday's OBV


The idea behind the OBV indicator is that changes in the OBV will precede price changes. A rising volume can indicate the presence of smart money flowing into a security. Then once the public follows suit, the security's price will likewise rise.
Like other indicators, the OBV indicator will take a direction. A rising (bullish) OBV line indicates that the volume is heavier on up days. If the price is likewise rising, then the OBV can serve as a confirmation of the price uptrend. In such a case, the rising price is the result of an increased demand for the security, which is a requirement of a healthy uptrend. 

However, if prices are moving higher while the volume line is dropping, a negative divergence is present. This divergence suggests that the uptrend is not healthy and should be taken as a warning signal that the trend will not persist.
The numerical value of OBV is not important, but rather the direction of the line. A user should concentrate on the OBV trend and its relationship with the security's price.


This chart shows how the OBV line can be used as confirmation of a price trend. The peak in September was followed by lower price movements that corresponded with volume spikes, thus implying that the downtrend was going to continue.

OBV and SharpCharts

Using SharpCharts, the On Balance Volume can be charted as an indicator. The optional parameter edits the amount of periods for the moving average overlay.