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Overview
On Balance Volume ("OBV") is a momentum indicator that relates volume to price change.
On Balance Volume was developed by Joe Granville and originally presented in his book
New Strategy of Daily Stock Market Timing for Maximum Profits.
Interpretation
On Balance Volume is a running total of volume. It shows if volume is flowing into or out
of a security. When the security closes higher than the previous close, all of the day's
volume is considered up-volume. When the security closes lower than the previous close,
all of the day's volume is considered down-volume.
A full explanation of OBV is beyond the scope of this book. If you would like further
information on OBV analysis, I recommend that you read Granville's book,
New Strategy of Daily Stock Market Timing for Maximum Profits.
The basic assumption, regarding OBV analysis, is that OBV changes precede price
changes. The theory is that smart money can be seen flowing into the security by a rising
OBV. When the public then moves into the security, both the security and the OBV will
surge ahead.
If the security's price movement precedes OBV movement, a "non-confirmation" has
occurred. Non-confirma-tions can occur at bull market tops (when the security rises
without, or before, the OBV) or at bear market bottoms (when the security falls without, or
before, the OBV).
The OBV is in a rising trend when each new peak is higher than the previous peak and
each new trough is higher than the previous trough. Likewise, the OBV is in a falling
trend when each successive peak is lower than the previous peak and each successive trough
is lower than the previous trough. When the OBV is moving sideways and is not making
successive highs and lows, it is in a doubtful trend. [See Figure 47]
Figure 47
Once a trend is established, it remains in force until it is broken. There are two ways
in which the OBV trend can be broken. The first occurs when the trend changes from a
rising trend to a falling trend, or from a falling trend to a rising trend.
The second way the OBV trend can be broken is if the trend changes to a doubtful trend
and remains doubtful for more than three days. Thus, if the security changes from a rising
trend to a doubtful trend and remains doubtful for only two days before changing back to a
rising trend, the OBV is consid-ered to have always been in a rising trend.
When the OBV changes to a rising or falling trend, a "breakout" has occurred. Since OBV
breakouts normally precede price breakouts, investors should buy long on OBV upside
breakouts. Likewise, investors should sell short when the OBV makes a downside breakout.
Positions should be held until the trend changes (as explain-ed in the preceding
paragraph).
This method of analyzing On Balance Volume is designed for trading short-term cycles.
According to Granville, investors must act quickly and decisively if they wish to profit
from short-term OBV analysis.
Example
The following chart shows Pepsi and the On Balance Volume indicator. I have labeled the
OBV Up, Down, and Doubtful trends.
A falling trend, as you will recall, is defined by lower peaks and lower troughs.
Conversely, a rising trend is defined by higher peaks and higher troughs.
Calculation
On Balance Volume is calculated by adding the day's volume to a cumulative total when the
security's price closes up, and subtracting the day's volume when the security's price
closes down.
If today's close is greater than yesterday's close then:
If today's close is less than yesterday's close then:
If today's close is equal to yesterday's close then:
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