On Balance Volume (OBV) was developed by Joe Granville in the 1960s and somewhat revolutionized trading indicators. Not only did the indicator consider volume, but also whether volume was pushing prices up or down. The indicator therefore acts as a confirmation tool for price trends, and when OBV and price are moving in opposite directions, it indicates that a price trend reversal could soon develop. Being able to utilize OBV requires an understanding of how the indicator operates, how it can be used to aid trading decisions, and its limitations.
Pick a starting point based on historical data. If it was an up day (moved above prior close), note the volume for that day as a positive number, for example +1,200,000. If it was a down day (moved below prior close), note the volume as negative, for example -1,200,000.
If the next day is positive add the volume to the prior volume.
If the next day is negative then subtract the volume from the prior total.
Keep a running total, adding volume on up days, and subtracting volume on down days. If a stock (or other market) closes at the same level as the prior close, there is no change to OBV.
Be sure to see our guide to Analyzing Trading Volume.
OBV is simply a running total of volume, but it can provide insight because it is dependent on quantity of volume, and not only whether the price moves higher lower. For example, a down day with 1,000,000 volume is not as significant if the next up day has 5,000,000 in volume. The volume indicates buyers are very active in pushing the price up, and therefore OBV will move up over the two day period, even though one day was down and the other up.
The actual OBV value isn’t important, since the number can be huge, near zero, negative or positive. Therefore the right axis of the OBV indicator can be ignored; what matters is how OBV is acting, and its trajectory.
All charts courtesy of StockCharts.com.
OBV Uses and Strategies
OBV is primarily used as a confirmation tool for trends, but is also believed to foreshadow price reversals because changes in volume will often precede major price changes. Based on this assumption—please read the OBV Limitations section below for more on this topic—the OBV indicator is used in three primary ways: confirmation, divergence and breakouts.
Confirmation was already shown in Figure 1. OBV should rise when price is rising, and fall when price is falling. This helps confirm the current price direction is likely to continue. Since prices move in waves, OBV will also typically reflect this. Use trendlines to indicate the current direction in both the price and OBV.
See also Trend Trading 101.
Since OBV can confirm price trends, it can also warn when price is about to change direction. Divergence is a warning signal, and occurs when the price is trending higher but OBV is either flat or dropping overall, or when the price is falling but OBV is flat or rising overall.
If the price trend is up, and OBV is now dropping (bearish divergence), take a short position when the price breaks below its current trendline. Place a stop loss above the most recent swing higher in price. Hold the trade for as long as OBV confirms it, and the price is trending lower. Exit if the price breaks above its trendline.
If the price trend is down, and OBV is now rising (bullish divergence), take a long position when the price breaks above its current trendline. Place a stop loss below the most recent swing lower in price. Hold the trade for as long as OBV confirms it. Exit if the price breaks below its trendline.
As divergences show, OBV can act before price, also making it a useful tool for indicating in which direction a price breakout could occur.
In figure three OBV breaks below support, but price doesn’t … at least not initially. As OBV continues to decline, though, eventually the price breaks below support, following the direction of OBV, which acted first.
Be sure to also read our Ultimate Guide to the MACD Indicator.
Granville believed that a change in volume direction, reflected by the OBV, will always occur before the price changes direction. Unfortunately, it’s not that easy; while the OBV may help forecast many reversals, it often does so because it forecasts too many, providing a large number of false signals along with the valid ones.
Another limitation of the OBV indicator is that a massive volume spike day can throw off the indicator for months. An earnings announcement, index rebalancing or institutional block trade can cause the indicator to spike or plummet, but the volume spike may or may not be relevant information.
Note how in Figure 4 a massive volume spike in June causes the OBV to plummet. OBV does begin to rise again in August and September to confirm the price rally, but the massive drop in June still makes the indicator and stock appear rather weak, which could have led traders to avoid a very nice rally, or worse yet, short it based on a divergence.
The Bottom Line
OBV is a simple running total of up day (added) and down day (subtracted) volume. If OBV is moving with price it confirms the current trend. Divergences between OBV and price indicates the price may be due for a reversal. Using trendlines can aid in spotting divergences and trading opportunities. OBV can also help forecast breakout directions in price. OBV is not without its faults though. Volume spikes can skew the indicator, making objective analysis more difficult. Also, while it may appear that OBV often leads price, this is often simply a case of searching for evidence we wish to find. Therefore, OBV is a tool to be used in addition to price analysis, but shouldn’t be relied on solely.
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