What Is On Balance Volume (OBV)?

The On Balance Volume (OBV) is a technical indicator that helps traders forecast potential price trends for an asset based on price movement and trading volume. During price fluctuations, OBV offers insight into volume-driven price moves and reflects net volume shifts.

An OBV trending upward represents accumulation, showing a rising buying pressure, whereas an OBV trending downward shows an increasing buying pressure.

As a trader, to capitalise on potential profit-making opportunities, understanding this indicator might be of help.

Understanding the Meaning of the Balance Volume Indicator

Developed by Joseph Granville in 1963, the on balance volume leverages trading volume related to an asset to anticipate its potential price movement. The developer suggested that the volume is one of the key driving forces behind significant shifts in asset prices.

Therefore, the OBV as a metric indicates that when the trade volume of an asset rises sharply, and there is no corresponding price change, a significant change in its price might be nearby. This price move might be upward or downward.

Based on this concept, and analysing the relationship between price and volume, on balance volume helps locate when asset prices are accumulating, i.e. buying pressure is rising. It represents an accumulation or a bullish sentiment using a rising OBV.

Conversely, it can also indicate when an asset is being distributed, i., selling pressure is rising. A falling OBV shows the emergence of a bearish sentiment in the market of an asset.

A Detailed Calculation Process for On Balance Volume

To understand OBV calculation better, you must note its applicable formulas. A hypothetical example might help gain an understanding of how it works in real-time trading:

1. Applicable Formulas for OBV Calculation

   Now that you have an outline of how you calculate the on balance volume indicator, you must have a look at its applicable formulas explicitly. Noting these formulas might help you to implement on balance volume trading strategy efficiently:

   When the closing prices of an asset during a current trading session are higher than its previous closing, you use this formula:

   Current OBV = previous OBV + current trading volume

   In case the closing price for the day is less than its closing on the previous session, the formula below applies:

   Current OBV = previous OBV – current trading volume

   However, there might be instances where both previous and current closing prices are the same. Here is how you calculate its current OBV in such a case:

   Current OBV = Previous OBV

2. An Example of the OBV Calculation

   To start with a practical implication, let us assume the closing of a hypothetical stock over 5 trading days, along with its volume:

   Suppose on Day 1, this stock closes at INR 102 with a volume of 25,200. On day 2, the closing price is INR 104 with a volume of 30,000. On Day 3, its closing price rose to INR 107 with a volume of 25,600.

   However, its closing price on Day 4 is a bit low at INR 105 with 32,000 as its volume. On the 5th day, it drops further and closes at INR 103 with a volume of 23,000.

   From this trend, the up days have been days 2 and 3. Down days are days 4 and 5. Considering the OBV of day 1 to be 0, here is a detailed calculation:

   OBV of Day 1 = 0

   OBV for Day 2 = previous OBV + current trading volume = 0 + 30,000 = 30,000

   The Day 3 OBV = 30,000 + 25,600 = 55,600

   OBV for Day 4 = previous OBV – current trading volume = 55,600 – 32,000 = 23,600

   Day 5 OBV = 23,600 – 23000 = 600

   From the above calculation, it is now clear that rising OBVs for Days 2 and 3 indicate an increasing buying pressure. While a dropping OBV for Days 4 and 5 indicates an increasing selling pressure.

   Thus, an on balance volume trading strategy helps confirm whether a real volume strength backs the price move. It allows you to validate the trend and judge if the move is reliable.

How to Interpret an On Balance Volume?

As you have noted the formulas and calculation process, to use an on balance volume indicator efficiently, you must note how to interpret it. Here is a detailed view:

1. Confirmation of Price Trend

   As you now know what is on balance volume, to interpret it and confirm a price trend, you must look at the move of the OBV. If an OBV (represented as an OBV line on charts) shows moving upward, it signifies a potential uptrend. A dropping OBV line shows a price downtrend, which means selling pressure is getting higher.

2. Interpret Divergence

   Interpreting a divergence between the price movement and the OBV indicates an early sign of a potential reversal. Suppose an asset price is making new lows, but instead of the respective OBV confirming these lows, it creates new higher lows. It signifies that despite a downward move, buying pressure is getting stronger, signalling a potential upside reversal.

3. Confirmation of Breakout or Breakdown

   You can use the on balance volume as an indicator to confirm a price breakout or a breakdown. Suppose a stock price breaks a key resistance level and OBV rises. It indicates buying pressure, and traders might choose to buy. If the price breaks below a support level, it shows a strong selling pressure, and traders might choose to sell here.

4. Interpret Trends With Other Indicators

   While as a trader, you might find an on balance volume indicator as a viable tool, using it in combination with other indicators might help with a better interpretation. Get a more robust trading signal by combining an OBV signal with trend lines, momentum oscillator, etc.

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How to Use On Balance Volume in Commodity Trading?

Aside from using it just for the stock market, you can use an on balance volume if you also trade in commodities. To understand how to use it for commodities, let us resort to another example:

Suppose you are trading in gold futures, and it is trading at INR 1,27,593. Its key resistance level is at INR 1,28,000, with the current OBV being at 10 lakh. After 2 days, its OBV rises to 15 lakh and gold futures break above the said resistance level.

As this OBV is on the rise, along with its prices rising, traders might confirm this signal of an uptrend. Here, traders might choose to open a long position or make a buying decision.

Limitations in using the On Balance Volume Indicator

After understanding the calculation, interpretation and its usage in commodity trading, you must note some of its limitations:

Reliability Concerns on Low Volume Assets

Being an indicator that relies on trade volume, an on balance volume might generate unreliable signals in the case of stocks with low volume. It especially happens with smaller company stocks where fewer buyers and sellers are engaged.

Not Suitable For Day Traders

As you already know, an OBV relies on closing prices of an asset after a trading session; it might not be suitable for intraday traders. Day traders require real-time price changes, and as OBV calculates after the market is closed, it might not be that effective for day trading decisions.

Conclusion

An on balance volume is a technical indicator to analyse price information of assets and respective trade volumes. Based on these, it forecasts the potential price direction of an asset so that traders can make informed trade decisions.

FAQ’s on On Balance Volume

1. Is On Balance Volume a good indicator?

OBV has the potential to forecast upcoming price movements to make trade decisions. You must use it by combining it with signals from other indicators for more accuracy.

2. What is the On Balance Volume formula?

If the closing price of the current day is higher than its previous close, you use Current OBV = previous OBV + current trading volume. When they are the same, then imply Current OBV = Previous OBV. If the current OBV is less than its previous, use Current OBV = previous OBV – current trading volume.

3. How to use OBV to trade commodities?

When OBV rises along with rising prices of a commodity, it signals a strong breakout. It suggests a buying opportunity. While falling OBV with falling prices confirms a breakdown, it indicates a selling opportunity. Furthermore, it assists in locating bullish or bearish divergences.

4. What is the On Balance Volume setting?

It is simply the running total of volume based on price changes. Traders might smooth it with a moving average, but the actual OBV calculation uses daily price and volume only.