On balance volume (OBV) is a price forecast method used primarily for stocks. It utilises changes in volume to predict stock price movements and was introduced in the early 1960s in Joe Granville’s book titled Granville's New Key to Stock Market Profits. Since then, on balance volume has become a popular crowd sentiment indicator that has been used to predict bullish or bearish outcomes for many other financial assets. In the same way, on balance volume can be used to predict the price of cryptocurrencies.
OBV Indicator Calculation
On balance volume is a cumulative indicator which adds volume of an asset on up days, while it subtracts volume on price down days, displaying the net result as a line on the technical analysis chart.
To derive the on balance volume of an asset, this is what we do:
When today's price is higher than yesterday’s price:
OBV = OBV (yesterday) + Volume today
When both prices are equal (previous day’s closing price and today’s closing price):
OBV = OBV (yesterday)
When today’s closing price is less compared to yesterday’s price:
OBV = OBV (yesterday) – Volume today
How To Read The On Balance Volume Indicator
The on balance volume indicator can be positive or negative, oscillating between zero, positive and negative values. It will be positive when the price of the current day is higher than the price of the previous day, while it will be negative if today’s price is lower than the last closing price.
On balance volume signals are based on the theory that volume precedes price. Hence, analysing changes in volume can give us an early indication of an imminent price change, which can help us anticipate the future price movements of an asset. In this regard, on balance volume is a good tool that can be used for predicting price reversals.
What Does OBV Tell Us?
The OBV is a technical indicator of momentum which can tell us potential smart money accumulation of an asset, similar to how the relative strength index (RSI) is able to tell us when an asset is overbought or oversold. As the OBV shows volume change, its divergence from price action usually indicates a forthcoming reversal. We will be looking into these in greater detail shortly.
How to Use The On Balance Volume Indicator with Margex
Margex is an easy to use crypto trading platform that offers a trader a suite of useful technical trading tools, as well as a high leverage option of up to 100x to help him maximise the potential of his trades. The OBV indicator is one such technical tool that Margex lets its customers use for free.
Let us show you how to find and use the on balance volume indicator on Margex.
On the trading screen once you sign up for an account and log in, go under “indicators” (yellow box) as shown in the diagram below and key in the words obv as shown (orange circle). After that, select the On Balance Volume tool as shown. The obv line will pop up on your price chart after that.
When using the on balance volume indicator to trade, our primary focus should be on its direction and not its number, as we can see in the below diagram, the number can be positive or negative.
The OBV directional change can tell you whether there is buyer pressure or seller pressure in the market, which has a variety of applications in trading. We shall discuss the various scenarios below.
A bearish divergence happens when price is rising while during the same time period, the OBV indicator falls. This is especially evident when the price forms a higher high but the on balance volume forms a lower high.
A bullish divergence occurs when price is decreasing but the OBV is increasing at the same time. Accordingly, for a bullish divergence, the price would display a lower low while the on balance volume makes a higher low.
Confirming The Trend
To confirm price trends, we need to watch if the OBV signal line moves in the same direction as the price. If both on balance volume and price are increasing at the same time, you can confirm an upward trend as the volume is growing in tandem to support the price growth. The converse is true for identifying a downtrend.
Potential Breakout or Breakdown From a Ranging Market
During ranging market conditions, we can watch for a potential breakout or breakdown from range by watching the on balance volume value rise or fall.
An increasing OBV value usually points towards a potential upward breakout in price because it indicates that accumulation is ongoing as more buyers come in, while a decrease in on balance volume may hint of a potential price breakdown because as distribution takes place, investors may have less of the asset left to sell.
Example of How to Use On Balance Volume in Crypto
Please note that this is just a product demonstration and not an enticement to trade nor is it financial advice. A trader should consider his own financial situation before trading any financial instrument and remember to not trade more than what you can afford to lose.
Now, let us use an example of on balance volume usage in crypto to confirm a change in price trend. As the price of cryptocurrencies is very volatile, very often, a trader is not sure if a price change is simply noise, or is a real change in direction. This is where the OBV indicator can come in to help a trader confirm if a real change in price trend is in place.
In our example of ETH below, one can see that the OBV line movement had the exact trajectory as the movement of ETH’s price. This can confirm the change in trend from bearish to bullish on 20 July 2021 when the OBV changed direction with the price. The new uptrend can be further confirmed since the OBV line rose as ETH’s price continues to go higher.
On 10 November 2021, the OBV indicator confirmed that the bullish trend was over when it formed a lower high compared with its previous OBV value when the price of ETH started to show signs of exhaustion, but had not shown a reversal signal yet. However, the price of ETH subsequently started declining and began a period of correction. Thus, acknowledging the lower high on the OBV could help a trader get prepared for the upcoming price reversal earlier.
Advantages of On Balance Volume Trading Indicator
On balance volume is straightforward, easy to understand and based on reasonable logic. When positive volume pressure exceeds negative volume pressure, the higher buying pressure drives prices up. When negative volume pressure exceeds positive volume pressure, the extra selling pressure sends prices down.
Since volume has a great impact on price, OBV can provide the much needed signal for a potential breakout or breakdown when the price action of a financial asset is stuck in a trading range and not showing any bullish or bearish inclination.
On balance volume can be used to confirm the direction of a trend when other indicators are showing mixed signals. In this regard, the usage of OBV allows traders another way to accurately spot divergences early.
Generally speaking, on balance volume is great to either confirm an underlying trend, or to look for divergences that may foreshadow a price change.
Limitations of OBV
While being a useful leading indicator, on balance volume is not without its limitations and a user will need to be aware of them and make the best use of its merits and faults.
One important consideration a user of the OBV needs to note is that OBV is prone to give false signals if used solely on its own. Users should try as much as possible to use OBV in conjunction with other technical indicators, such as basic chart pattern analysis or with other momentum oscillators like the MACD or RSI to confirm the signals given by OBV.
For instance, adding a moving average to the OBV line can help better predict breakouts. A user can confirm a breakout in the price if the OBV indicator makes a concurrent break in the same direction as with the moving average. This gives the user a higher chance of correctly predicting bullish or bearish breakouts.
Furthermore, the OBV’s false signals are especially apparent when using it on a lower time frame because within a shorter duration, the price has noise due to the higher price volatility, which can produce incorrect prevailing trends. Thus, users are advised to not use OBV for predicting near term price changes on lower time frame charts.
On balance volume also does not account for the degree of price movement as the same volume is added or subtracted regardless of how big the price movement was, this may not accurately depict the actual amount of buying and selling pressure.
For instance, a surprise announcement from a stock, or a massive central bank trade on a currency pair may cause its OBV indicator to show a big swing, but the spike in volume may not be indicative of a trend but is a mere one time off event.
Lastly, on balance volume, as a single line indicator, may not incorporate enough market data needed for comprehensive price action analysis.
Now that we know what is OBV indicator, what are its benefits and limitations, readers could try incorporating it into your trading routine and see if it helps to improve your profitability.