Definition of On-Balance Volume (OBV) & How I Use It
- orionstafa
- May 28, 2022
- 4 min read
What is On-Balance Volume (OBV) and how does it work?
On-balance volume (OBV) is a technical trading momentum indicator that forecasts stock price fluctuations based on volume flow. Granville's New Key to Stock Market Profits, published in 1963, was the first book to introduce the OBV metric. 1
Granville believed that volume was the most important factor in markets, thus he created OBV to forecast when large market shifts would occur based on volume fluctuations. He compared the forecasts made by OBV to "a spring being wound tightly" in his book. When volume spikes without a noticeable change in the stock's price, he believes the price will eventually surge upward or downward.
Calculating OBV
On-balance volume is a running total of an asset's trading volume that shows whether it is flowing in or out of a particular security. The OBV is a total of all volumes (positive and negative). When computing the OBV, there are three guidelines to follow. They are as follows:
1. If today's closing price is higher than yesterday's closing price, then: Current OBV = Previous OBV + today's volume
2. If today's closing price is lower than yesterday's closing price, then: Current OBV = Previous OBV - today's volume
3. If today's closing price equals yesterday's closing price, then: Current OBV = Previous OBV
What Can You Learn from On-Balance Volume?
OBV is predicated on a contrast between smart money — institutional investors – and less skilled ordinary investors. Even if the price remains stable, volume may increase when mutual funds and pension funds continue to buy into an asset that ordinary investors are selling. The price will eventually rise due to increased volume. Larger investors begin to sell at this stage, while smaller investors begin to buy.
The actual individual quantitative value of OBV is irrelevant, despite being plotted on a price chart and quantified quantitatively. The indication is cumulative, but the time period is set by a dedicated starting point, therefore the real number value of OBV is based on the start date arbitrarily. Traders and analysts instead focus on the nature of OBV movements over time, with the slope of the OBV line carrying all of the analysis weight.
Volume figures on the OBV are used by analysts to track major, institutional investors. They consider volume and price differences as a metaphor for the interaction between "smart money" and the general public, intending to highlight opportunities for buying against incorrectly prevalent trends. Institutional money, for example, may drive up the price of an asset, then sell once other investors get on board.
How To Use On-Balance Volume as An Example
The following is a list of a hypothetical stock's closing price and volume over the last ten days:
Day one: closing price equals $10, volume equals 25,200 shares
Day two: closing price equals $10.15, volume equals 30,000 shares
Day three: closing price equals $10.17, volume equals 25,600 shares
Day four: closing price equals $10.13, volume equals 32,000 shares
Day five: closing price equals $10.11, volume equals 23,000 shares
Day six: closing price equals $10.15, volume equals 40,000 shares
Day seven: closing price equals $10.20, volume equals 36,000 shares
Day eight: closing price equals $10.20, volume equals 20,500 shares
Day nine: closing price equals $10.22, volume equals 23,000 shares
Day 10: closing price equals $10.21, volume equals 27,500 shares
As can be seen, days two, three, six, seven and nine are up days, so these trading volumes are added to the OBV. Days four, five and 10 are down days, so these trading volumes are subtracted from the OBV. On day eight, no changes are made to the OBV since the closing price did not change. Given the days, the OBV for each of the 10 days is:
Day one OBV = 0
Day two OBV = 0 + 30,000 = 30,000
Day three OBV = 30,000 + 25,600 = 55,600
Day four OBV = 55,600 - 32,000 = 23,600
Day five OBV = 23,600 - 23,000 = 600
Day six OBV = 600 + 40,000 = 40,600
Day seven OBV = 40,600 + 36,000 = 76,600
Day eight OBV = 76,600
Day nine OBV = 76,600 + 23,000 = 99,600
Day 10 OBV = 99,600 - 27,500 = 72,100
OBV vs. Accumulation/Distribution
In the same way that on-balance volume and the accumulation/distribution line are both momentum indicators that use volume to predict the movement of "smart money," on-balance volume and the accumulation/distribution line are both momentum indicators that use volume to predict the movement of "smart money." The similarities, however, stop there. The volume on-balance is calculated by adding the volume on up days and subtracting the amount on down days.
The accumulation/distribution (Acc/Dist) line is created using a different formula from the OBV displayed above. Without becoming too technical, the Acc/Dist calculation takes the current price's position relative to its previous trading range and multiplies it by the volume for that period.
OBV's Limitations
One drawback of OBV is that it is a leading indicator, which means it can make predictions but not much about what has actually transpired based on the signals it generates. As a result, it's prone to sending out erroneous signals. As a result, lagging indications might be used to balance it out. To watch for OBV line breakouts, add a moving average line to the OBV; if the OBV indicator produces a concomitant breakout, you can confirm a price breakout.
Another thing to keep in mind when utilizing the OBV is that a high-volume surge on a single day might throw the indicator off for a long time. A surprise earnings release, being added or deleted from an index, or big institutional block transactions, for example, might cause the indicator to spike or fall, although the volume surge may not be indicative of a trend.
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