The On Balance Volume (OBV) indicator, developed by Joseph Granville in the 1960s, measures buying and selling pressure by assessing how trading volume influences price movements. It achieves this by calculating cumulative total volume and correlating it with price levels.
Understanding the On Balance Volume (OBV) Indicator
- OBV stands for On Balance Volume.
- This indicator quantifies market buying and selling pressure.
- It focuses specifically on market volume data.
Holding cash in a bank account offers minimal returns in today’s economic climate. As a result, many individuals are turning to securities trading as a more attractive wealth-building alternative. This trend has increased the number of private investors and financial service providers—from traditional banks to online brokers.
Consequently, there is growing demand for practical trading tools and guidance among both novice and experienced traders. The On Balance Volume indicator is one such tool, though it is not a recent innovation. This article explores its functionality, advantages, limitations, and practical applications in trading strategies.
What Is the On Balance Volume (OBV)?
Financial markets are influenced by numerous factors, with price and trading volume being among the most critical. The Dow Theory emphasizes that volume confirms trends: when markets move in a trend, volume increases; when prices move against the trend, volume decreases.
Building on this principle, Joseph Granville created the OBV indicator. His work significantly impacted stock market analysis during his time, and professional traders continue to use OBV across various financial markets today.
The OBV indicator is used in technical analysis to measure buying and selling pressure. It estimates how existing trading volume affects price movements by calculating cumulative total volume and comparing it to price action.
On days when the closing price is higher than the previous day, the day’s volume is added to the cumulative OBV. On days when the closing price is lower, the volume is subtracted. The absolute value of OBV is less important than its direction, as the starting point of the calculation varies.
Typically, OBV moves in alignment with price. However, deviations between OBV and price can signal trading opportunities, indicating movements not supported by volume.
The OBV indicator is widely used in the following strategies:
- Trend and trendline analysis
- Trend reversal and divergence spotting
- Trend following
We will explore these strategies in detail later. First, let’s examine the advantages and limitations of using OBV.
Advantages and Limitations of Using OBV
The OBV indicator is particularly useful in Forex trading, offering relatively reliable entry and exit signals. However, it should not be used alone. For meaningful insights, OBV must be combined with other technical indicators.
Additionally, beginners may find OBV challenging to interpret, making it more suitable for experienced traders.
Advantages:
- Provides reliable trading signals
- Well-suited for Forex markets
Limitations:
- Requires combination with other indicators
- Can be complex for novice traders
Trading with On Balance Volume
Price action is central to chart analysis, and OBV serves as a valuable tool for interpreting market momentum. Generally, OBV aligns with price movement. It is applied in trend analysis, trend reversal detection, and trend following—for both long and short trading.
Below, we outline optimal conditions for entering long and short positions using OBV.
Long Trading with OBV
Traders should display the weighted moving average (WMA) with a 233-day period alongside OBV. Both the price and OBV WMAs should initially trend upward.
If the price WMA turns negative while the OBV WMA remains positive, a divergence occurs. A long position should be opened when the price WMA reverses back into positive territory.
Short Trading with OBV
For short positions, both the price and OBV WMAs should trend downward over a 233-day period.
When the price WMA turns positive while the OBV WMA remains negative, a divergence is present. A short position is signaled when the price WMA shifts back into negative territory.
Installing OBV on MetaTrader
MetaTrader is one of the most widely used trading platforms globally. To apply the OBV indicator in MetaTrader 4 (MT4) or MetaTrader 5 (MT5), open the platform and click "Insert" in the toolbar.
Next, select "Indicators," go to "Volumes," and choose "On Balance Volume." The indicator will then be applied to the chart.
The OBV indicator is commonly used for stocks, Forex, and indices but can also be effective for cryptocurrency trading due to its high volatility.
Trading Strategies Using OBV
The OBV indicator is frequently incorporated into the following strategies:
- Trend and trendlines
- Trend reversal and divergence
- Trend following
We now explore each of these in depth.
Trend and Trendlines with OBV
The core concept of OBV is that total volume increases when a security’s closing price is higher than the previous day’s close. Conversely, volume decreases when the closing price is lower. The cumulative total volume forms the OBV line.
A change in the direction of the OBV line may indicate an impending price shift. For example, if traders begin aggressively buying a financial instrument, OBV will rise, reflecting increased buying pressure that could drive prices higher.
If volume stops increasing during an uptrend, it suggests weakening buying pressure, often signaling that the bullish trend may be losing momentum. The same logic applies to bearish trends.
To confirm trend weakening, Granville recommended using a moving average (MA) alongside OBV. Crossings between the OBV line and its moving average help traders identify potential trend changes more efficiently. When OBV diverges from price action, a reversal may be imminent. For instance, if the price rises while OBV begins falling, traders should prepare to sell. Conversely, if the price falls while OBV rises, a buying opportunity may be approaching.
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Trend Reversal and Divergence with OBV
OBV can also be used to identify trend reversals and divergences. Often, OBV moves before price, hinting at the direction of a potential breakout.
For example, if the price forms a lower low but OBV forms a higher low, this is known as a bullish divergence. If OBV forms a lower high while the price forms a higher high, it is called a bearish divergence.
Experienced traders often open a short position under these conditions: an upward trend shows a bearish divergence in OBV, and the price breaks below its current trendline. A stop-loss order is placed above the recent swing high. The trade is maintained as long as OBV confirms the downtrend and the price trends downward toward support.
A long position is opened when a downward trend shows a bullish divergence in OBV, and the price breaks above the current trendline. A stop-loss is set below the recent swing low, and the trade is held while OBV confirms the trend and the price trends upward toward resistance.
The OBV divergence strategy works best when the price is near resistance for short trades or near support for long trades. Some traders also incorporate pivot indicators, though these are often available only in the MetaTrader Supreme Edition.
Trend Following with OBV
Traders using OBV for trend following should incorporate these indicators:
- Daily pivot points
- Bollinger Bands with a 50-period setting
- OBV with a 20-period exponential moving average (EMA)
This strategy is popular in Forex trading, especially for pairs like EUR/JPY and GBP/JPY. The H1 time frame is commonly used, along with Bollinger Bands set to a 50-period width to allow for larger price fluctuations.
Trading signals are generated when the price breaks out of the upper or lower Bollinger Band. A long position is opened when the price re-enters the bands from below. The 20-period EMA is then applied to OBV. If OBV breaks above this EMA and closes above it, the third component—the pivot resistance level—comes into play.
The profit target is the first, second, or third pivot resistance level above the entry point. A stop-loss is set 5 pips below the most recent low.
For short positions, traders enter when the price breaks above the upper Bollinger Band and then re-enters the bands. OBV must break downward through the EMA and close below it. The target is the first, second, or third pivot support level below the entry, with a stop-loss placed 5 pips above the recent high.
Conclusion: Best Used in Combination with Other Indicators
Joseph Granville developed the On Balance Volume (OBV) indicator in the 1960s. It measures buying and selling pressure by calculating cumulative volume and assessing its impact on price movements.
As Charles Dow noted in the late 19th century, volume increases when markets trend and decreases when prices move against the trend. OBV is widely used in Forex trading across multiple strategies. However, it is most effective when combined with other indicators for confirmation. Its complexity also makes it better suited for experienced traders than beginners.
Frequently Asked Questions
What does OBV indicate?
OBV is a cumulative total that calculates the net difference between buying and selling volume for an asset. It helps traders gauge buying or selling pressure in the market.
What other volume indicators are available?
Besides OBV, popular volume indicators include the Accumulation/Distribution Line (A/D), Volume Price Trend (VPT), Money Flow Index (MFI), Chaikin Money Flow (CMF), Volume Oscillator, Klinger Oscillator, and Volume by Price. Each measures different aspects of volume-price relationships.
Which indicators pair well with OBV?
OBV is commonly combined with moving averages, RSI, MACD, Stochastic Oscillator, Bollinger Bands, and VWAP. For reliable trading signals, it should always be used alongside at least one other indicator.