On balance volume

Granville's on balance volume indicator is a great indicator and can almost be used by itself, although this is not really recommended. It works on the premise that rather large commercial traders accumulate or disperse the commodity in volume prior to a corresponded move in price. That is, a change in volume will precede a potential change in the trend.

On Balance Volume is a running total, volume indicator that is arrived at by adding or subtracting the day's volume, depending on whether the closing price is higher or lower than the previous close. If the close is higher then the volume is added and if the close is lower the volume is subtracted. It requires about 40 data points before a meaningful signal can be generated.

On Balance Volume OBV = Previous Days OBV + today's volume (if the closing price is higher)

OBV = Previous Days OBV - today's volume (if the closing price is lower)

How to use

If the market is trading in a range the indicator is likely to also reflect that by remaining in its own range, however the indicator will often breakdown or breakout from its own range prior to price breaking down or breaking out from its range. Therefore the simplest application of Granville's On Balance Volume Indicator is to buy when the indicator breaks out from its recent range and sell when it breaks down from its range. It might take price a day or even two to confirm the move, so patience and other supporting trend change indicators will help.

If the market is currently trending then the indicator can be used to confirm the continuation of the trend or alert to a potential change in trend. Divergence between price and the indicator can be used to signal a potential change in trend. That is, if the OBV is rising while price is falling then the move is unlikely to continue. Conversely, if the OBV is falling while price is rising, the up move is likely to fail.

In the example below you can see that the OBV broke out of its range just prior to price breaking out and then gapping higher. You will also notice that each time the OBV has moved to a new high, price has followed shortly after, which is to be expected as both price and the indicator are moving in an up trend.


© Copyright 2003 CQG, Inc. All rights reserved worldwide

Disclaimer
© The MacLean Group Pty Ltd ACN 096 967 038. All rights reserved 2003. This article has been prepared by The MacLean Group and licensed to ASX. The views are those of the author and not of ASX. This material is educational and it is not intended to constitute financial advice.