What Is On-Balance Volume (OBV)?
What Is On-Balance Volume (OBV)?
On-Balance Volume (OBV) is a technical momentum indicator that uses volume flow to predict price changes in financial markets. Developed by Joseph Granville in 1963, OBV helps traders anticipate market movements by analyzing volume shifts that occur without significant price changes. Granville believed that volume is a key driver of market trends, and when volume rises sharply without a price spike, it often signals a pending breakout or breakdown.
For forex traders, OBV can offer valuable insights into market sentiment and help confirm trends, making it a useful tool for identifying potential price reversals.
Formula for On-Balance Volume (OBV)
where:
- OBV = Current on-balance volume level
- OBVprev = Previous on-balance volume level
- Volume = Latest trading volume amount
Calculating On-Balance Volume (OBV)
On-Balance Volume (OBV) is a running total of an asset’s trading volume, providing insight into whether volume is flowing into or out of a particular security or currency pair. It serves as a cumulative measure of positive and negative volume, which can help traders identify shifts in market sentiment and potential price movements. OBV is especially useful in forex trading, where volume often plays a critical role in confirming trends or signaling reversals.
When calculating OBV, three rules are applied:
1. If today’s closing price is higher than yesterday’s closing price:
Current OBV = Previous OBV + today’s volume
This suggests buying pressure and signals that more volume is entering the market, potentially pushing prices higher.
2. If today’s closing price is lower than yesterday’s closing price:
Current OBV = Previous OBV – today’s volume
This indicates selling pressure, with more volume leaving the market, which could signal an impending price drop.
3. If today’s closing price equals yesterday’s closing price:
Current OBV = Previous OBV
No significant change in market sentiment is observed, and volume remains neutral.
OBV’s strength lies in its ability to reflect the underlying volume flow, giving forex traders a clearer picture of whether volume supports a price movement. It’s particularly valuable when used alongside other indicators, allowing traders to make more informed decisions about potential market shifts.
What Does OBV Tell You?
The theory behind On-Balance Volume (OBV) centers around the behavior of “smart money”—institutional investors—and how their actions differ from less informed retail investors. In forex and other markets, when large institutional players, such as mutual funds and hedge funds, start buying into a currency pair or asset that retail investors are selling, OBV can capture the increase in volume, even if the price remains steady. Over time, this accumulation of volume tends to push the price upward. Once prices rise, institutional investors may begin selling, while smaller investors are drawn in, often late to the move.
While OBV is plotted on a price chart and calculated numerically, the actual quantitative value of OBV isn’t crucial. Since the indicator is cumulative, its numerical value depends on the starting point, which varies arbitrarily. Instead, the focus is on the direction and slope of the OBV line. A rising OBV slope indicates buying pressure and a likely price increase, while a declining slope points to selling pressure.
For forex traders, the true value of OBV lies in its ability to track volume trends that may indicate the actions of large institutional investors. Analysts often look for divergences between price and OBV movements, using these as potential indicators that institutional money is moving against the prevailing trend. For example, if price is rising but OBV is falling, it could indicate that institutional investors are quietly exiting the market before a potential downturn.
By paying attention to these divergences, forex traders can better align their strategies with market momentum and avoid being caught on the wrong side of major moves, making OBV a powerful tool in identifying hidden opportunities and risks.
Example of How to Use OBV
To better understand how On-Balance Volume (OBV) works, let’s look at a hypothetical example using 10 days of a stock’s closing prices and trading volumes. This example could easily apply to forex trading, where the flow of volume is critical in identifying potential market movements.
The closing prices and volumes for the 10 days are as follows:
• Day 1: Closing price = $10, Volume = 25,200 shares
• Day 2: Closing price = $10.15, Volume = 30,000 shares
• Day 3: Closing price = $10.17, Volume = 25,600 shares
• Day 4: Closing price = $10.13, Volume = 32,000 shares
• Day 5: Closing price = $10.11, Volume = 23,000 shares
• Day 6: Closing price = $10.15, Volume = 40,000 shares
• Day 7: Closing price = $10.20, Volume = 36,000 shares
• Day 8: Closing price = $10.20, Volume = 20,500 shares
• Day 9: Closing price = $10.22, Volume = 23,000 shares
• Day 10: Closing price = $10.21, Volume = 27,500 shares
In this scenario, the OBV is calculated by adding or subtracting volume based on whether the closing price increased or decreased compared to the previous day. If the price rises, the volume is added to the previous day’s OBV, signaling buying pressure. Conversely, if the price falls, the volume is subtracted, signaling selling pressure. When the closing price remains unchanged, the OBV stays the same, indicating neutral market sentiment.
Here’s how the OBV is calculated over the 10 days:
1. Day 1 OBV = 0 (starting point)
2. Day 2 OBV = 0 + 30,000 = 30,000 (price up)
3. Day 3 OBV = 30,000 + 25,600 = 55,600 (price up)
4. Day 4 OBV = 55,600 – 32,000 = 23,600 (price down)
5. Day 5 OBV = 23,600 – 23,000 = 600 (price down)
6. Day 6 OBV = 600 + 40,000 = 40,600 (price up)
7. Day 7 OBV = 40,600 + 36,000 = 76,600 (price up)
8. Day 8 OBV = 76,600 (price unchanged)
9. Day 9 OBV = 76,600 + 23,000 = 99,600 (price up)
10. Day 10 OBV = 99,600 – 27,500 = 72,100 (price down)
As seen from the example, days when the closing price increases (days 2, 3, 6, 7, 9) result in positive volume being added to the OBV. When the closing price decreases (days 4, 5, 10), volume is subtracted from the OBV. On day 8, the price remained constant, so the OBV did not change.
For forex traders, this OBV example demonstrates how tracking volume flow can provide insights into market trends. OBV helps confirm whether price movements are supported by strong buying or selling pressure. By monitoring OBV alongside price action, traders can spot potential reversals or breakouts, making it a valuable tool for anticipating shifts in market sentiment.
