On Balance Volume Definition: Day Trading Terminology

On Balance Volume

On Balance Volume Definition: Day Trading Terminology

On Balance Volume (OBV) is a momentum indicator that helps to measure the buying and selling pressure. As a cumulative indicator, On Balance Volume adds volume on up days and subtracts on down days. It utilizes volume flow thus predicting changes in stock price.

According to savvy traders, the stock that closes higher than the previous close is considered up volume but when it lowers than the previous close, it’s considered down volume. What you need to know is that volume is an important trading indicator that helps to provide information about the strength of price movements.

OBV is known to take volume analysis way beyond the volume bars as typically seen on a price chart. Furthermore, it helps to present an illustration of the volume flow for a particular stock thus allowing traders and investors to compare them against price action.

Origin of On-Balance Volume

As a momentum indicator, the On-Balance Volume was developed by John Granville. He introduced the momentum indicator in his book titled “Granville’s New Key to Stock Markets Profits” in 1963. John Granville was able  to determine that volume is the main driving force behind the markets.

As a result, he developed the OBV with the goal of determining major moves occurring in the markets. He proceeded by describing the increase and decrease of his momentum indicator as well as the setting of new highs or lows as “a spring being wound tightly.”

According to the explanation provided by John Granville regarding OBV, he stated that when volume increases or decreases dramatically without any significant change in price then the price of the security is bound to move up or down.

Thanks to OBV, traders are able to check for divergences between OBV and price thus predicting the movement of price. Furthermore, OBV can be used to confirm price trends.

How to Calculate On-Balance Volume

It is important to note that OBV is basically a running total of volume. Not only can the momentum indicator provide better insight into a security price movement but it’s dependent on volume. In trading, you may find that on a down day 1,500,000 in volume is not that significant especially if the next up day will be higher than 5,500,000 in volume.

From the scenario above, it indicates that buyers are active thus pushing the price of the security upwards which means OBV will move up during the next two day period.

What you need to know is that the actual OBV value is not that important. This is because the value may be larger, near zero, positive or negative. Here the right axis of the OBV maybe ignored but the most important thing is the way OBV acts plus its trajectory.

Here is how to calculate the OBV:

Since OBV runs the total of volume whether positive or negative, three rules must be implemented. They include:

1. When the closing price of a security is higher than the previous day closing price, then
Current OBV = Previous OBV + current volume
2. When the closing price of a security is lower than the previous day closing price, then
Current OBV = Previous OBV + current volume
2. When the closing price is equals the previous trading day closing price, then
Current OBV = Previous OBV

Final Thoughts

As one of the most popular momentum indicators, OBV is known to focus on the value of volume and how it affects the price of a security. OBV was developed to measure the positive and negative flow of volume against the current price of the security.

As a simple measure, it keeps the total of volume through the addition and subtraction of volume according to price movement. With OBV, traders are able to confirm trends and divergences. To get the most out of the On-Balance Volume, it should be used together with basic chart pattern analysis.