On Balance Volume
On Balance Volume Technical Indicator (OBV) is a momentum technical indicator that relates
volume to price change. The indicator, which Joseph Granville
came up with, is pretty simple. When the security closes higher
than the previous close, all of the day’s volume is considered
up-volume. When the security closes lower than the previous
close, all of the day’s volume is considered down-volume.
The basic assumption, regarding On Balance Volume analysis, is that OBV
changes precede price changes. The theory is that smart money
can be seen flowing into the security by a rising OBV. When the
public then moves into the security, both the security and the
On Balance Volume will surge ahead.
If the security’s price movement precedes OBV movement, a
"non-confirmation" has occurred. Non-confirmations can occur at
bull market tops (when the security rises without, or before, the OBV) or
at bear market bottoms (when the security falls without, or before,
the On Balance Volume Technical Indicator).
The OBV is in a rising trend when each new peak is higher than the
previous peak and each new trough is higher than the previous trough.
Likewise, the On Balance Volume is in a falling
trend when each successive peak is
lower than the previous peak and each successive trough is lower than
the previous trough. When the OBV is moving sideways and is not making
successive highs and lows, it is in a doubtful trend.
Once a trend is established, it remains in force until it is broken.
There are two ways in which the On Balance Volume trend can be broken. The first occurs
when the trend changes from a rising trend to a falling trend, or from a
falling trend to a rising trend.
The second way the OBV trend can be broken is if the trend changes to a
doubtful trend and remains doubtful for more than three days. Thus, if the
security changes from a rising trend to a doubtful trend and remains doubtful
for only two days before changing back to a rising trend, the On Balance Volume is considered
to have always been in a rising trend.
When the OBV changes to a rising or falling trend, a "breakout" has occurred.
Since OBV breakouts normally precede price breakouts, investors should buy long
on On Balance Volume upside breakouts. Likewise, investors should sell short when the OBV
makes a downside breakout. Positions should be held until the trend changes.
Calculation
If today’s close is greater than yesterday’s close then:
OBV(i) = OBV(i-1)+VOLUME(i)
If today’s close is less than yesterday’s close then:
OBV(i) = OBV(i-1)-VOLUME(i)
If today’s close is equal to yesterday’s close then:
OBV(i) = OBV(i-1)
