On-Balance Volume: how to use it for Technical Analysis

There are lots of methods for traders to use technical analysis. Here we want to focus on the concept of Volume

Technical analysis is one of the two methods of analysis when it comes to financial trading. Fundamental analysis is involves looking at the economic, political, and macro events and analysing their impact on currencies and stocks. It is a good method that has had significant results over the years.

Technical analysis on the other hand is much simple because it involves using tools such as moving averages, relative strength index, and stochastic oscillator to predict the future prices.

These indicators are developed by using several mathematical calculations. There are several types of technical indicators.

In this article, we will look at On Balance Volume, which is not well-known by traders.

How to Master Technical Analysis

What is On Balance Volume Indicator?

As the name suggests, On Balance Volume is a volume-based indicator. Volume indicators use the concept of volumes to help traders make better decisions.

To understand the importance of volume, you need to consider a simple example: suppose that the price of tomatoes went up suddenly when shoppers were not there. This price could go up, but it will likely come down as soon as more shoppers start to buy.

This is why volume indicators are very important.

How to Read on balance volume

On Balance Volume is an indicator that was developed by Joe Granville in 1963. He wrote a book known as Granville New Key to Stock Market Profits.

The indicator simply runs a total of positive and negative volume. A period is usually said to be positive when the close is above the previous close. It is said to be negative when its close is below the previous close.

How to calculate it?

A calculation using the following on balance volume formula:

  • Current OBV = Previous OBV + Current Volume (This applies when the closing price is above the previous closing price.

  • Current OBV = Previous OBV – Current Volume

  • Current OBV = Previous OBV (if the closing price is equal to previous close price)

The main idea behind OBV is that volume precedes price. As such, OBV tends to rise when volume on up days outpaces volume on down days. Instead, it falls when volume on down days is stronger.

At the same time, a rising OBV is an indication of positive volume pressure that can lead to higher prices.

How to use the On Balance Volume

Using the on-balance volume is a relatively easy process because it is usually built-in in most trading platforms like the TradingView and MetaTrader. Therefore, you don’t need to install it in the marketplace.

Second, you need to look at the chart you are analyzing because the indicator is not suitable for all chart types. It is recommended that you use it when the price of an asset is trending upwards or downwards.

As you will realize, the indicator does not work well when the price of an asset is ranging.

Finally, you need to check the indicator’s timeframe. When using TradingView, the default selection is the same as the chart. It is recommended that you make this selection since it won’t make sense to analyze a weekly chart with a daily OBV.

On Balance Volume strategy

As with all other indicators, you don’t need to know how to calculate the OBV indicator. All you need to do is to apply it on your charts and then interpret it. Also, you need to know that OBV works well on trending markets.

Indeed, it should not be used when markets are consolidating.

You need to know that OBV works well when it is used in combination with other indicators. These indicators could be the likes of moving averages and relative strength index.

» Technical Analysis: Briefing

Follow and confirm trends

One way of using the on balance volume is to follow and confirm a trend, as shown on the chart below. As seen, the price of EUR/USD pair rose when the OBV indicator was on an upward trend. The price started to decline when the OBV was declining.

Therefore, it is easy to use the indicator when the price is rising. Another way of using the indicator is to find when a currency pair or stock wants to diverge and move lower.

On balance volume EUR-USD

Combine with other indicators

Another strategy of using the on-balance volume is to combine it with another indicator. The most popular way, as stated above, is to combine it with a moving average and find the crossovers.

For example, in the chart below, buying and selling signals emerged when the on-balance volume made a crossover with the moving average.

How OBV and EMA works together. Chart from Tradingview

Summary

The On-Balance-Volume (OBV) is an important technical indicator in the market. It appears as a single line that tends not to tell a lot about a financial asset. However, when used well, it can help you identify where to buy or sell an asset.

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