In financial markets, volume is the sum of all buying and selling activity on a given asset over a predetermined period. Since the price of financial assets varies according to the volume indicator on trading, volume is of great importance in interpreting future price movements and trends. With this comprehensive guide, you will be able to get extensive information about On-balance Volume, a volume-based indicator, including how it is calculated, how it is used in trading, and its advantages and disadvantages!
What Is On-Balance-Volume?
The on-balance volume (OBV), a volume-based indicator, allows for the prediction of future price movements through the price-volume relationship by tracking the changing volume values during past price movements. According to the basic working principles of OBV, volume always precedes price, providing traders with several insights regarding the relationship between volume and price.
On-balance Volume was first introduced in 1963 by Joseph Granville in his book “Granville’s New Key to Stock Market Profits”. In Granville’s book, OBV was defined as an indicator for analyzing the volume believed to be behind all kinds of price movements. Granville states that even if there is a momentary difference movement during the rise or fall in volume, it will eventually affect the price.
How Does On-Balance-Volume (OBV) Work?
The basic working principle of OBV is to analyze the relationship between volume and price movements. According to Granville’s theory, volume acts as a driving force for any price movement and volume is the most fundamental element in any price movement. Through OBV, traders can get confirmation by seeing whether there is volume support in breakouts or price movements that signal trend reversals.
What Is The Formula For On-Balance-Volume (OBV)?
OBV is a tool that aggregates the total trading values of a financial asset and allows traders to interpret them. The formula used in the calculation of OBV may vary according to the previous day’s statistics. Three different rules apply to the application of OBV:
- If today’s closing price is higher than yesterday’s closing price, then: Current OBV = Previous OBV + today’s volume
- If today’s closing price is lower than yesterday’s closing price, then: Current OBV = Previous OBV – today’s volume
- If today’s closing price is equal to yesterday’s closing price, then: Current OBV = Previous OBV
What Are The Advantages Of On-Balance-Volume (OBV)?
- Easy to Understand: Traders who want to use On-balance Volume do not need any technical knowledge. By integrating OBV into their charts, financial participants of all levels can easily interpret the correlation between price and volume and assess the direction and momentum of the market without the complexity of formulas.
- Predicting the Trend: Since its introduction by Granville, OBV has generally been adopted as a leading indicator. According to this approach, volume shows itself first and price movements follow behind. When volume movements are very volatile, traders can interpret the current situation in different ways, such as potential trend reversals or a continuation of an existing strengthening trend. In this way, traders can also manage their investment strategies and change their portfolio allocations.
- Usability: Volume is a factor that affects all markets. Each price movement is the result of trading activity for the relevant financial asset, and since all trading activity is volume, On-balance Volume, which functions as a volume-based indicator, has become a tool that can be used in any financial market. Traders in all areas of financial assets such as stock markets, indices, cryptocurrencies, and commodities use OBV to identify current market conditions.
What Are The Disadvantages Of On-Balance-Volume (Obv)?
- Inefficiency in Sideways Markets: In sideways markets, the price tends to move within a narrow range and the use of OBV can be misleading or lead to errors in generating a direct signal. In this sense, for the most accurate results, it is recommended to use OBV when the trend direction is clear and should always be used in conjunction with other technical indicators.
- Volume Only: Only volume levels are taken into account when performing calculations on On-balance Volume. In the event of technical issues where volume levels may be delayed or inaccurately reflected, traders may draw the wrong inference. For this reason, it is always important to obtain prior confirmation for any trades.
- Misinterpretations: Volume can be considered as a financial element that can be expressed quite volatile on different timeframes. Traders interested in trading on longer terms should examine daily, weekly, and monthly volume data. In such a case, following volume movements in very short periods may cause the trader to obtain false signals.
How Does On-Balance-Volume Differ From Other Types Of Volume Oscillators?
Oscillators generally track cycles in financial assets. Volume-based oscillators, on the other hand, combine available volume data to help infer the future direction of the price. Changes in volume reveal various overbought and oversold conditions, providing traders with signals to utilize in their trading strategies.
On the other hand, OBV evaluates volume data by following a cumulative approach over time. Unlike the complex formulas used in oscillators, OBV can be interpreted much more easily and provides traders with data on the momentum of price movements. The resulting data provides a comprehensive perspective on whether the trend is likely to continue or reverse.
What Is The Importance Of On-Balance-Volume (OBV)?
Supply and demand function as the main determinants of the price movements of a financial asset. Volume, on the other hand, is the name given to all buying and selling transactions on a financial asset. The most important factor for those who make long or short-term investments to make a profit is the realization of the volume levels at the rate they expect. For this reason, volume is always of great importance in trading transactions and investors should always pay attention to it. On-balance Volume is frequently used by market participants as an important indicator that provides traders with various insights into trend momentum and possible trend reversals by aggregating cumulative volume values.
How Can On-Balance-Volume (OBV) Be Used To Identify Trends In The Market?
On-balance Volume is not an indicator to be used directly to determine the direction of the trend, but it acts as a bit more supportive. Traders interested in gaining insight into the strength of the current trend and the sentiment of traders can follow OBV indicators. In scenarios where the indicator is aligned with price movements, it can be inferred that more participants are involved in the trend, while the divergence between the indicator and price can be a supportive argument for a potential trend reversal.
What Is The Best Trading Strategy For On-Balance-Volume (OBV)?
Although the best trading strategy to use the OBV depends on traders’ personal preferences, it is often beneficial to use it in combination with other indicators that generate signals for entry and exit points. Indicators such as moving averages, which show traders the upward or downward momentum of a trend, are more likely to produce more accurate results when supported by a confirmation tool such as volume. As a supportive indicator, OBV can provide various insights into the momentum of price movements obtained with other indicators.
Which Is The Best Time To Trade Using On-Balance-Volume (OBV)?
Since volume is an indispensable element for any asset in the financial markets, it can be monitored at any time. For traders who want to improve their trading strategies through OBV, there are a number of time frames to choose from. For example, OBV tends to perform best in trending markets where sustained price movements are supported by corresponding volume.
On the other hand, OBV can also be used to gauge how markets will react to any news in the light of geopolitical or economic developments. An increase in the volume levels expressed on the OBV during these periods may indicate that a major market move is coming.
Is On-Balance-Volume (OBV) A Good Indicator?
Yes, OBV is a very good and important indicator. All price movements in financial markets are driven by volume. For this reason, traders also track volume data to make predictions about the future direction of the price and the trend. However, even though it is a purely volume-based indicator, the OBV can occasionally produce false signals, so it is always important that the inferences from other indicators are equivalent to those obtained from the OBV.
Is On-Balance-Volume (OBV) An Oscillator?
No, On-Balance Volume is not an oscillator. OBV is a volume-based trend-following indicator rather than an oscillator with cyclical ups and downs. While oscillators usually provide information on a number of different issues, such as overbought and oversold when they break below or above certain levels, there are no predetermined thresholds for interpreting OBV.
FAQ
How can I add the On-balance Volume to the charts?
The On-Balance Volume is available in the indicators section of many trading platforms. If OBV is selected as an indicator to be displayed, it will automatically appear on the chart.
Can the On-balance Volume be used on any timeframe?
Yes, the On-Balance Volume can be used on all timeframes, depending on traders’ strategies.
Can the On-balance Volume be applied to all financial instruments?
Yes, the On-Balance Volume can be used for all financial instruments.
Is the On-balance Volume suitable for all traders?
On-balance Volume is an indicator suitable for traders of all levels, as it does not involve complex formulas and is easy to understand.
Does On-balance Volume always provide an accurate signal?
No, OBV tends to generate more accurate signals in trending markets and is always recommended to be used in conjunction with other indicators.
Disclaimer
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