While volume may help investors predict where price action will go, on-balance volume offers sharper indications that help investors act on a transaction. As price bars carve out patterns that forecast a bullish or bearish result, volume reveals crowd mood.
Convergence is created when volume supports price movement, increasing dependability to directional signals. Divergence occurs when opposing forces operate, indicating that market forces are at odds, with one side finally gaining control. The interpretation of volume via an accumulation-distribution indicator simplifies this process, providing accurate signals that impact position selection and trade management.
On-balance volume (OBV), invented by Joseph Granville in the 1960s, crams a lot of functionality into a basic accumulation-distribution tool that counts up and down volume, adding or removing the result in a continuous sub-total. The algorithm produces a smooth indicator line that carves out highs, lows, and trendlines in the same way as price bars do. Comparing price bar relative activity to OBV yields more actionable alerts than the green or red volume histograms often seen at the bottom of price charts.
- On-balance volume (OBV) is a basic accumulation-distribution technique that counts up and down volume, generating a smooth indicator line that may be used to forecast when large market swings may occur based on changes in relative trading volume.
- OBV works best when tested around significant highs and lows to look for potential breakouts and collapses.
- OBV may be used by investors to make a variety of significant forecasts, such as a bullish divergence forecasting that the market will break resistance or a bearish divergence indicating that a rally would halt or reverse.
The OBV Feedback System
OBV provides the most dependable input around significant highs and lows, making it an ideal tool for predicting breakouts and collapses. It’s a straightforward technique that involves comparing the indicator’s development to price activity and noting any convergence or divergence associations. This opens the door to a slew of significant predictions:
- OBV reaches a new high as the price approaches resistance: bullish divergence, indicating that the price will break resistance and surge higher, catching up.
- The price rises to a new high but the OBV remains at or below the previous resistance level: bearish divergence, indicating that the advance will stall or reverse.
- OBV strikes a new low as the price tests support: bearish divergence, suggesting that the price will break support and surge lower, catching up.
- The price falls to a new low but the OBV remains at or above the previous support level: positive divergence, indicating that the sell-off will halt or reverse.
- OBV follows price activity, rising or falling: bullish or bearish convergence, depending on direction.
On the daily chart, limit OBV analysis to important testing zones. During a sideways market, it is inevitable for competing correlations between price and volume to emerge, lowering the indicator’s dependability across disputed levels. It also does not scale well, with intraday and weekly OBV producing inconsistently trustworthy indications.
Limit your analysis to tests at levels that have been in place for months to get the most out of OBV. This increases the likelihood of obtaining more relevant results, which may raise your bottom line.
Examples of OBV
Let’s look at two common OBV scenarios:
Image by Sabrina Jiang © Investopedia2021
CME Group (CME) surges to 80 in June (1), with an OBV strong swing. It pulls back and surpasses the November high, but OBV fails to reach its earlier high (2), indicating a bearish divergence. The rally fails, resulting in a sell-off that hits an 11-month low in April. The stock then enters an accumulation period, with both the OBV and the price rising in lockstep for seven months. OBV rises to a multiyear high in September (3), but the price remains below the preceding year’s high, resulting in a positive divergence that foreshadows the powerful December breakout.
Image by Sabrina Jiang © Investopedia2021
Celgene Corporation reaches a high in early 2014, slightly around 90 (1), and then initiates a downturn with a wide dispersion. It begins to rebound in April, gaining territory in a steady increase that propels price over the previous peak in June, while OBV falls short.
The stock grinds sideways in a symmetrical triangle for two months before breaking out (2) and soaring above 100, while OBV continues to lag, grinding considerably below the peak set earlier in the year. This divergence causes the uptrend to stop and undercut the breakout level, scaring away potential buyers while OBV recovers slowly and steadily, eventually joining price at a new high in November (3).
When OBV lags price behavior, stocks may easily breakout or breakdown, but the divergent activity raises a warning signal that anticipates whipsaws until the price turns to meet OBV or OBV turns to meet the price. The second step of the action or response resolution cycle is tracked by this testing behavior. As a result, traders should wait for OBV to equal the lead price before entering fresh breakout or breakdown positions.
The Bottom Line
On-balance volume reveals market participants’ intentions, typically before price action provides a buy or sell signal. As a result, investors may utilize OBV to get insights that will aid them in making trading choices. It’s especially handy as an entrance filter when a security is testing a big support or resistance level.
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