On-Balance Volume Method
On-Balance Volume is a popular volume based technical indicator developed by Joseph Granville in 1963. This indicator lies onus on tracking the momentum by correlating the volume of the trades to the change in price of the underlying currency / stock. This indicator aims to look out for trends where higher number of buyers / sellers form a bullish / bearish scenario respectively. The underlying assumption for this indicator is that volume overtakes the price movements. Many traders prefer OBV, as it is a running indicator. It adds the volumes to identify the cash inflows & outflows. OBV is mainly used to compare the volumes with the currency prices, thus identifying any diverging signal or confirmation.
The Method
- In an “up trend†or a “bullish†market on a particular day, the volume of that day is added to OBV.
oآ آ آ I.E Present OBV = OBV Yesterday + Today’s Volume
- In a “down trend†or “bearish†market, the trade volume is subtracted from the OBV.
oآ آ آ I.E Present OBV = OBV Yesterday – Today’s Volume
- OBV is not affected when the closing prices don’t change.
oآ آ آ I.E Present OBV = OBV Yesterday (No change)
The Uses
OBV goes with the assumption – “Volumes lead Priceâ€. The changes in the volumes are largely based on direction. If the volumes are high on a day, the in flow of the money into that currency is also high. Thus, people trade more leading to increase in the price. When the volume is more in an up-trend, it is denoted by the “bullish†line. If the price follows the up-trend, the OBV confirms the up-trend. This is a healthy market scenario. But if the volumes drop even when the price moves up, it is noted as a “negative divergence†signal. This indicates of an unhealthy trend and a trader should not go by this trend. A smart trader does not go by the inflated figure of the OBV, but by the OBV trend and its correlation to the currency prices.
The Disadvantages
The disadvantage of OBV, which traders cite out, is its idea of generalizing. OBV only considers the direction in which the price moves. Since the variable increase / decrease in the price is ignored, traders argue that it may at times not provide the correct signal. For instance – If the previous day closing price of 1 USD = 0.80 EUR and the present day closing price is 0.90 EUR, the OBV considers only today’s closing price. But the movements of price in the whole trading day, which range between 0.80 to 0.90 EUR are ignored. If these movements and their relative volumes are considered while calculating OBV, the method turns out to be more accurate.
Forex traders always think of ways to enhance the indicator that they use for trading. One way to make the OBV indicator more effective to help trading decisions is to use chart trading. Still traders have differing opinions on how to enhance this indicator, this method is yet popular and most used one for Forex trading.
Tip From ForexStar
