On Balance Volume

Cabot_Square,_Canary_Wharf_-_June_2008

 

 

Investors are using many indicators of technical analysis to find the one that will give them the best trading signals. Are they looking for an indicator that does not give wrong signals? It would be great, but unfortunately, it is not possible. It is enough, however, with the right way of managing capital, when the indicator gives at least 50% of correct trading signals. It can be said that it’s not brain surgery to achieve half of profitable trades – you can toss a coin as well. Whoever, however, has been trading even for a short time in the financial markets knows perfectly well that trading moves away from statistics and when trading randomly, you lose more than you earn. This is explained by market psychology and the inability of keeping the nerves calm. Is this really true? Hard to say. But actually, it is not important at all. It is important that trading blindly makes you lose money. The reason is irrelevant.

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Looking for further tools to protect you from losses, for sure you will come across the On Balance Volume indicator, the OBV indicator. This is a recognizable but somewhat niche indicator of technical analysis. In terms of popularity, it’s far from the Moving Average Convergence Divergence or Relative Strength Index. However, we’ll discuss later whether it deserves a place in the group of the most popular Forex indicators.

As the name implies, the On Balance Volume takes the trading volume into account, so although it can be used in the Forex market, it is best to use it on markets with the exact volume available, for example, futures or shares market. On Balance Volume is one of four basic volume indicators, along with Money Flow Index, Volumes, and Accumulation / Distribution tools.

Construction and operation of On Balance Volume

One of the basic assumptions of technical analysis is that the change in volume is a confirmation of trading signals that show the change in the trend. The rule here is quite simple – a drop in volume, that is, a decrease in turnover during an uptrend can be a signal of the end of an uptrend, and a drop in volume during a downtrend means a depletion of supply. The assumptions underlying the On Balance Volume are similar to those of the Money Flow Index.

The OBV measures both the level of turnover and price system on both sides – and compares them to each other. It shows how the proportions between the capital incoming and outgoing from the market look. The operation of the indicator can be presented by simple patterns:

if C (x) > C (x-1) to OBV (x) = OBV (x-1) + V

in turn if C (x) < C (x-1) to OBV (x) = OBV (x-1) – V

and when C (x) = C (x-1) to OBV (x) = OBV (x-1)

In the patterns, C (x) is the current closing price, C (x-1) is the closing price in the preceding period and V is the turnover volume.

In conclusion, if the price of an instrument increases in relation to the closing price of a preceding period, the turnover volume is added to the index value, and if the price of the instrument falls in relation to the closing price of the preceding period, the volume is subtracted from the index value.

Use of On Balance Volume

We can not write a lot about using the On Balance Volume indicator because it is very easy. We can decode it by finding the divergence between its readings and the price, because it is a pre-emptive indicator. The increase in the value of the index, while the price of the instrument decreases, is a sign that the sale is going to end, and the fall in the value of the index as the price of the instrument grows is a signal to take short positions.

The OBV is a solid AT tool. Is it better or worse than other volume indicators? Hard to say. A matter of taste. The OBV, MFI and AD are relatively similar. In the case of the OBV there is one issue worth attention. Its readings are based only on the search for divergence, and the search for divergence between price and indicators is a very frustrating task because they are relatively rare. When using On Balance Volume, you have to be patient. The same is true for the accumulation / distribution index.

Advantages of On Balance Volume

  • Ease of use
  • Relatively clear transaction signals
  • Possibility of using the indicator in broader strategy

Drawbacks of On Balance Volume

  • Low amount of signals

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