On-Balance Volume Trading Strategies
On-Balance Volume (OBV) is a popular technical analysis indicator that measures buying and selling pressure in the financial markets. It was first introduced by Joe Granville in the 1960s, and since then, it has become a widely used tool among traders and investors.
In this article, we will provide an introduction to On-Balance Volume, including how it works, how to interpret it, and how to use it in your trading strategy. Whether you are a novice or an experienced trader, this article will provide you with the knowledge and tools you need to incorporate OBV into your trading toolbox.
What Is On-Balance Volume?
On-Balance Volume is a technical analysis indicator used to measure buying and selling pressure by tracking the cumulative volume of an asset over time. OBV is classified as a momentum indicator because it measures the strength of price trends by analyzing the flow of volume.
The OBV indicator works by adding the volume of an asset to a running total if the asset’s price closes higher than the previous day’s closing price. Alternatively, if the price closes lower than the previous day’s closing price, the volume is subtracted from the running total. If the closing price remains unchanged, then no volume is added or subtracted from the OBV line. As a cumulative indicator, it can be anchored manually or automatically to a specific point in time or lookback period for more meaningful data. This is called the Anchored On-Balance Volume in TrendSpider.
The theory behind OBV is that changes in the volume of an asset precede price movements. In other words, when the OBV is rising, it suggests that buying pressure is increasing, and the price is likely to continue its upward trend. Conversely, when the OBV is falling, it indicates that selling pressure is increasing, and the price is likely to continue its downward trend.
OBV is typically displayed as a line chart that runs along the bottom of a price chart. The OBV line is plotted on the y-axis, while the x-axis represents time.
On-Balance Volume Trading Strategies
Here are some on-balance volume trading strategies:
Divergence Strategy
In the OBV divergence strategy, traders look for discrepancies or divergences between the price of an asset and its OBV indicator. Specifically, traders look for situations where the price of an asset is making higher highs or lower lows, while the OBV indicator is making lower highs or higher lows. This type of divergence suggests that the momentum behind the price movement is weakening, and that a potential reversal in trend may be forthcoming.
To implement the OBV divergence strategy, traders will typically wait for a confirmation signal, such as a break of a trendline or a moving average, before taking a position. Traders may use additional technical indicators or price action analysis to further confirm the divergence signal and to determine entry and exit points for their trades.
Trend Confirmation Strategy
The OBV trend confirmation strategy involves analyzing the relationship between the price of an asset and its OBV indicator over time. In an uptrend, the OBV indicator should generally be making higher highs and higher lows, indicating that the buying pressure behind the asset is increasing. In a downtrend, the OBV indicator should generally be making lower highs and lower lows, indicating that the selling pressure behind the asset is increasing.
To implement the OBV trend confirmation strategy, traders will typically look for situations where the price of an asset is making a new high or low, while the OBV indicator is also making a new high or low in the same direction. This type of confirmation suggests that the trend is strong and that the buying or selling pressure behind the asset is likely to continue.
Traders may also look for divergences between the price of an asset and its OBV indicator to confirm or negate a trend. For example, if the price of an asset is making a new high, but the OBV indicator is making a lower high, this could be a warning sign that the uptrend may be losing momentum and could be due for a reversal.
Breakout Strategy
The OBV breakout strategy involves analyzing the relationship between the price of an asset and its OBV indicator over time. In a breakout, the price of an asset will typically break through a key level of support or resistance, indicating a shift in the balance of supply and demand. Traders can use the OBV indicator to confirm or negate a breakout signal by analyzing whether the OBV indicator is also breaking through a key level of support or resistance.
To implement the OBV breakout strategy, traders will typically wait for a confirmation signal, such as a break of a trendline or a moving average, before taking a position. Traders will also typically look for a surge in OBV volume, indicating that there is significant buying or selling pressure behind the asset, which can help confirm the strength of the breakout or breakdown.
Traders may also use additional technical indicators or price action analysis to further confirm a breakout signal and to determine entry and exit points for their trades. For example, traders may look for a breakout in combination with a bullish chart pattern, such as a cup and handle, to further confirm a bullish breakout signal.
Pros and Cons of On-Balance Volume
Like all technical analysis indicators, On-Balance Volume has its pros and cons. Here are some of the key advantages and disadvantages of using OBV:
Pros:
- Easy to interpret: The OBV indicator is easy to interpret since it only has two states – positive and negative. When the indicator is moving upwards, it indicates that there is more buying pressure than selling pressure. Conversely, when the indicator is moving downwards, it indicates that there is more selling pressure than buying pressure.
- Works well with trending markets: The OBV indicator works well with trending markets, as it is designed to identify buying and selling pressure in a market. In trending markets, the OBV indicator can help traders identify the direction of the trend and confirm the strength of the trend.
- Can be customized: The OBV indicator can be customized to suit different trading styles and preferences. For example, traders can adjust the period used to calculate the OBV indicator to make it more or less sensitive to changes in volume.
Cons:
- Leading indicator: The OBV indicator is a leading indicator, which means that it may provide false signals if the market conditions change suddenly. It is important to use the OBV indicator in conjunction with other technical indicators and fundamental analysis to confirm any signals.
- Sensitive to spikes in volume: The OBV indicator is sensitive to spikes in volume. If there is a sudden increase in trading volume, it can cause the OBV indicator to move rapidly in one direction, which may not necessarily reflect the underlying trend in the market.
- Not suitable for all markets: The OBV indicator may not be suitable for all markets, such as thinly traded markets or markets with low volatility. In such cases, the OBV indicator may produce false signals or may not provide enough information to make an informed trading decision.
Overall, OBV can be a useful tool for traders to confirm trends and identify potential trend reversals, but it should be used in conjunction with other indicators and trading strategies for a more complete picture of an asset’s price action.
Example scanners and strategies that use On-Balance Volume
The Bottom Line
In conclusion, On-Balance Volume is a popular technical analysis indicator that measures buying and selling pressure based on changes in trading volume. While it is not a perfect indicator and can have its drawbacks, it can be a valuable tool for traders to confirm trends, identify potential trend reversals, and make trading decisions.
