How to use On-Balance Volume indicator to ascertain stock price movement

Volume plays a decisive role in the stock market. It reflects the interest of market participants and assists in projecting the price fluctuations. A definitive study of the volume structure provides a greater degree of cushion in trading, especially in a volatile environment.

 

Joshep Granville developed the On-Balance Volume (OBV) in 1963. He believed volumes have a greater impact on the price and assessing the same would provide an edge while analysing price movement. He also discovered that when the volumes see an increase without any movement in stock price, the price is certain to see a sharp up or down move in the near course.

 

OBV analyses the total volume to determine whether investors are actually buying or selling. To achieve the same, the indicator analyses previous OBV with current volumes. The basic idea is to build an indicator that shows upward buying momentum or downward selling momentum. Whenever the price shows successive positive closing, the OBV is said to rise. This is due to the calculation of adding volumes on positive – green close -- and deducting the same on negative close.

 

In a nutshell, OBV is a broad study that needs to be deeply understood to get an edge over price. There is no doubt that the price can itself trend, but any support from OBV can make the trend firm or weak. Technical analysts form trading strategies after considering price indicators, volumes, and technical indicators. This method has been beneficial as it covers all the major aspects of the stock market.

 

Why is OBV a relevant indicator?

 

-- Volumes help in breakouts. There are various technical indicators depending on the volume structure. Their trading signals are lucrative when supported by the volume indicator. A breakout without volumes on any indicator depicts weaker strength.

 

-- Volume may not give the entry or exit levels, but significant volumes at current levels may act as support.

 

-- Price-action and candlestick patterns rely more on the volume distribution.

 

-- Gap-up and gap-down signals are purely based on the volumes.

 

-- Divergence on the OBV indicator can provide signals on the overall trend.

 

-- A sharp rise or decline in price may not always result in a rally in the same direction until the OBV supports the trend.

 

OBV vs A/D indicator

 

The OBV and accumulation/distribution indicator are quite different in nature. OBV relies on the positive or negative closes, whereas accumulation/distribution studies the changes in prices to the recent price movement and then multiplies the same with volumes. 

 

Limitations of OBV indicator

 

-- The indicator may provide positive signals, but is not accurate in identifying reversal in trend.

 

-- Any development in industry/economy/business can create wild swings in volumes, which may not actually have any relevance to the price.

 

-- OBV helps in confirming a trend but is not reliable in depicting the entry points.