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 trendâ€‌ or a “bullishâ€‌ 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 trendâ€‌ or “bearishâ€‌ 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 “bullishâ€‌ 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 divergenceâ€‌ 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

One of the most simple and popular technical analysis indicators is the moving averages method. This method is known for its flexibility and user-friendliness. This method calculates the average price of the currency or stock over a period of time. The term “moving averageâ€‌ means that the average moves or follows a certain trend. The aim of this tool is to indicate to the trader if there is a beginning of any new trend or if there is a signal of end to the old trend. Traders use this method, as it is relatively easy to understand the direction of the trends with the help of moving averages.
Moving average method is supposed to be the simplest one, as it helps to understand the chart patterns in an easier way. Since the currency’s average price is considered, the price’s volatile movements are evened. This method rules out the daily fluctuation in the prices and helps the trader to go with the right trend, thus ensuring that the trader trades in his own good.

We come across different types of moving averages, which are based on the way these averages are computed. Still, the basis of interpretation of averages is similar across all the types. The computation of each type set itself different from other in terms of weightage it lays on the prices of the currencies. Current price trend is always given a higher weightage. The three basic types of moving averages are viz. simple, linear and exponential.

A simple moving average is the simplest way to calculate the moving price averages. The historical closing prices over certain time period are added. This sum is divided by the number of instances used in summation. For example, if the moving average is calculated for 15 days, the past 15 historical closing prices are summed up and then divided by 15. This method is effective when the number of prices considered is more, thus enabling the trader to understand the trend and its future direction more effectively.

A linear moving average is the less used one out of all. But it solves the problem of equal weightage. The difference between simple average and linear average method is the weightage that is provided to the position of the prices in the latter. Let’s consider the above example. In linear average method, the closing price on the 15th day is multiplied by 15, the 14th day closing price by 14 and so on till the 1st day closing price by 1. These results are totaled and then divided by 15.

The exponential moving average method shares some similarity with the linear moving average method. This method lays emphasis on the smoothing factor, there by weighing recent data with higher points than the previous data. This method is more receptive to any market news than the simple average method. Hence this makes exponential method more popular among traders.

Moving averages methods help to identify the correct trends and their respective levels of resistance.

Tip From ForexStar

The moving averages method is believed to be simple and flexible method of calculating the average currency price over a certain time period. However, a Forex trader may be confused on the selection of the time period for moving averages. If the trader wishes to compare two moving averages with two different time periods, the best method to go for is the Double Crossover Method. Instead of one moving average pattern, the trader can select a short-term and a long-term moving average on the same screen and compare the two for deciding on the future price trend. In simple words, it is about using two moving averages to generate trading signals.

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The double crossover method helps generate buy/sell signals with the use of two moving averages patterns. Trading decisions can be made in a simpler way with this method. When the shorter average pattern crosses over the longer one, the signal indicated is a “BUY (Bullish)â€‌ one. Similarly, when the longer average pattern crosses over the shorter one, the signal is taken as a “SELL (Bearish)â€‌ signal.

There are many combinations in which the double crossover method may be employed. Some popular combinations used in this method are 5-20 DMA (Days Moving Averages), 20-50 DMA or 10-50 DMA. Though this method may give some misleading signals known as “whipsawsâ€‌, but it yet lags the market due to use of historical data. This method may not have the trader exactly near the dot trend, but gets him somewhere closer to the same. Still, double crossover moving average method is considered to be one hand above the traditional simple moving averages method. The reason for the same is that the double crossover method uses two patterns of moving averages instead of one.

We have tried to explain this concept through a graphical example above. The pink line in the graph above represents a 5-DMA and the red line represents a 20-DMA. At the lower end of the graph, you can see the pink line crossing over the red line. Since the shorter moving average crosses the longer one, the intersection point is indicated as a “BUYâ€‌ signal. Similarly when the longer moving average crosses over the shorter one at the top of the graph, the intersection point is a “SELLâ€‌ signal.

The double crossover method is apt for currencies those follow the trends than market ranges. Some traders may question the use of closing prices of currencies while calculating the moving averages. Some may use a mid-value price, while few others may use price bands for day’s high & lows prices. Altogether, use of two averages for crossover can help detect buy/sell signals more effectively.

While analyzing crossover trends, a trader must see that the moving averages cover a lengthened time span. If the time span covered is less, lesser is the use of the trend to understand the signals. If the moving averages show a flat direction or a turned movement, it means that there can be trend reversal. Hence a trader must evaluate the trend patterns correctly to understand the right signals

Tip From ForexStar

In this of posting I’ll introduce to you some of the best money management methods that have been developped by Elder Alexander, the great forex and stock traders. In his book “Come to my trading roomâ€‌ in chapter 7 that labeled “Money Management Formulasâ€‌, he introduced the 2%-6% rules money management strategy.

Sharks and piranhas :

Elder said “The goal of money management is to accumulate equity by reducing losses on losing trades and maximizing gains on winning trades.â€‌ and he affirm that Everyone in the market (competitor traders and brokers) want to eat your money, they have two ways to eat your money:

1- A big single shark bite that wipe of all or the most of your capital.

2- A series of small piranhas bites that none of them is lethal alone but which together strip an account to the bone.

The 2%-6% rules is the Money Management method that protects you from the sharks and piranhas.
2% limit rule:

The first thing you should do to keep your balance away of the sharks is to limit your lose at any trade to 2% of your equity. If you have 100,000 USD in your trading account. So, you have to risk 100,000 x 2% = 2,000 USD in any of your trades. You have to set your stop loss to this level and you have not lose at any trade you make more than 2% of your equity. Some of professional traders use less than 2% but no more than 2%.

Whenever you make a loss or a profit you have to recalculate the 2% of the equity to know your new maximum risk per trade. For example if you made a profit trade and your account now is 110,000 USD, your maximum risk will be 2,200 USD. At the other hand if you made a loss and and your account now is 90,000 USD, your maximum risk will be 1,800 USD.

tip from kickforex