Technical Analysis

Importance

The On Balance Volume (OBV) indicator has been around for a long time. It was introduced in 1963 as a way to measure positive and negative money flow into securities. The concept behind its usefulness is that “volume precedes price” and therefore an understanding of volume is crucial to understanding the direction of price.

Why is OBV Important?

On Balance Volume can act as a leading indicator to predict upcoming price changes. Trendline analysis works well for this purpose. OBV gives direction to the volume indicator, which helps a trader to see if there is buying pressure or selling pressure, and if the price chart is conforming to that pressure. OBV can help identify trends that can be traded, a change of sentiment by investors, and divergences in which price is heading in the opposite direction of the prevailing buying or selling pressure.

Since OBV is one of the most basic indicators to enhance the regular volume indicator, it is recommended that a trader learn or at least have an understanding of its workings in order to trade better. An experienced trader usually wants several indicators that can work together, one that is based on volume (like OBV), one based on momentum (like RSI or Stochastic), and one based on volatility (ATR or Bollinger Bands). Combining these various indicators will give a clearer picture than using 3 momentum based indicators, for example, that all tell you a currency’s overbought/oversold levels.

Function

“On Balance Volume will precede price changes.”

Rising volume can indicate the presence of smart money flowing into a currency. When the public follows suit, prices will rise. That is why an upturn in volume during the start of a price move can be an important indication that a new trend may be forming. A rising OBV line indicates that trading is heavier during up periods. The price action should reflect this bullish sentiment by trending up. If price is moving down while OBV is rising, the downward price action should be followed with close scrutiny.

Volume does not differentiate between an up or down period. On Balance Volume changes that and adds a dimension of direction to the volume indicator that should correspond with price’s movement. When price goes higher but on lower volume, there is a disconnect between the direction of price and the amount of traders setting that price. A trader that is using On Balance Volume can avoid this disconnect because he sees volume moving up and down depending on whether the price closed up or down.

As a result, On Balance Volume works very well as a way to combine price and volume.

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