OBV
Definition
The On-Balance Volume (OBV) indicator, introduced by technical analyst Joe Granville in 1963, is a quantitative indicator used to analyze the relationship between trading volume and price movement. OBV is designed to measure market participation by tracking cumulative volume changes, based on the theory that "volume precedes price." It assumes that volume trends often shift before price trends.
OBV accumulates the daily trading volume by adding it to the cumulative OBV total when the price rises, and subtracting it when the price declines. The OBV value is then plotted as a trend line, which reflects potential changes in market sentiment, helping investors identify trend strength or possible reversals.
How to Calculate OBV Indicator
The calculation of the OBV indicator is based primarily on the closing price movements and corresponding trading volume:
If the current closing price is higher than the previous closing price:
Current OBV = Previous OBV + Current Volume
If the current closing price is lower than the previous closing price:
Current OBV = Previous OBV - Current Volume
If the current closing price is equal to the previous closing price:
Current OBV = Previous OBV
This cumulative process generates the OBV value, which allows observation of volume flow.
How to Use OBV Indicator
OBV itself has only one signal line, and trading bots determine buy or sell signals through crossovers.
Going Long: When the fast line crosses above the slow line and the price shows an uptrend, initiate a long position.
Going Short: When the fast line crosses below the slow line and the price shows a downtrend, initiate a short position.
Advantages
The On-Balance Volume (OBV) indicator is an excellent measure of buying and selling pressure. Many believe that buying and selling pressure leads price changes, making this indicator valuable. Divergence, in particular, should always be considered as a possible trend reversal.
OBV is a powerful tool to supplement trading strategies with volume-based signals. It is a real-time indicator, making it a favorite among day traders. Long-term investors also use it, and professionals who want to add volume-based insights to their analysis also rely on OBV.
Leading Signals: OBV often changes ahead of price, serving as a tool for predicting price movement and giving early signals to investors.
Simplicity: OBV's calculation is straightforward and easy to observe in combination with price charts.
Market Sentiment Insight: OBV provides a clear reflection of volume changes, helping to understand investor sentiment and buying or selling intentions in the market.
Disadvantages
Sensitivity to Abnormal Fluctuations: A single day's unusually large trading volume can cause abrupt changes in OBV, potentially affecting accuracy.
Limited in Sideways Markets: In a consolidating market without a clear trend, OBV may produce misleading signals.
Lagging Risk: Although considered a leading indicator, volume changes in some market conditions may not immediately impact prices, potentially causing lagging effects.
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