On Balance Volume (OBV)

🔍 What is OBV?

On Balance Volume (OBV) is a momentum-based technical indicator that relates volume flow to price movements. Developed by Joseph Granville in the 1960s, OBV attempts to measure buying and selling pressure as a cumulative indicator—adding volume on up days and subtracting volume on down days. Granville believed that volume precedes price, so OBV can serve as an early signal of future price movements.

This makes OBV particularly useful for identifying trend strength, potential reversals, and confirming price actions with volume dynamics.

⚙️ How It Works

OBV is calculated by taking the cumulative total of volume based on whether the asset closes higher or lower than the previous close:

• If today’s closing price is higher than yesterday’s, the volume is added to the OBV.

• If today’s closing price is lower, the volume is subtracted from the OBV.

• If today’s close is equal, OBV remains unchanged.

The formula can be expressed as:

OBV = Previous OBV ± Current Volume

The resulting line moves up and down based on the volume associated with price changes. While the OBV value itself is not as important, the direction and divergence of the OBV line relative to price is what traders focus on.

📖 How to Read OBV

Reading OBV involves tracking the trend direction of the OBV line and comparing it with the price trend:

• Rising OBV confirms an uptrend—volume is supporting the price increase.

• Falling OBV confirms a downtrend—volume is supporting the price decrease.

• Divergence between OBV and price often signals potential reversals:

  • If price is rising but OBV is falling, it may indicate weakness in the trend.

  • If price is falling but OBV is rising, it may suggest an impending bullish reversal.

  

OBV is often plotted as a single line on a separate panel below the price chart.

⚙️ Best Settings

The OBV indicator doesn't require parameter adjustment because it is not based on moving averages or smoothing factors—it only reacts to price closes and volume. However, here are some best practices:

• Use OBV with trendlines: Draw support and resistance on the OBV line to spot breakouts ahead of price.

• Combine with moving averages: Use MA on price to filter trades based on OBV signals.

• Use higher timeframes: OBV tends to produce more reliable signals on 4H, daily, or weekly charts.

OBV works best in trending markets, especially when price action is unclear but volume movements are strong.

🧠 How to Use OBV in a Strategy

Here are a few strategic ways to incorporate OBV into your trading:

1. Trend Confirmation

Use OBV to confirm price trends. For example:

• If price breaks resistance and OBV breaks a previous high, the breakout is supported by volume and likely valid.

• If OBV does not confirm the breakout, the move may be false or lack strength.

2. Divergence Trading

Spot divergences between price and OBV:

• Bearish divergence: Price makes higher highs while OBV makes lower highs → possible reversal.

• Bullish divergence: Price makes lower lows while OBV makes higher lows → potential bounce or trend change.

3. Breakout Anticipation

Sometimes OBV breaks out of a range before price does, providing early entry opportunities. This is based on the belief that smart money moves volume before the market catches up.

4. Volume-Based Stop Loss

You can also use OBV to validate stop-loss levels. If OBV suddenly reverses direction without price doing so, it could be an early sign to tighten your stops.

⚠️ Common Mistakes

1. Ignoring price structure: OBV should not be used in isolation. It's a supporting tool, not a standalone signal.

2. Over-relying on divergence: Divergences can persist for long periods. Always use confirmation.

3. Applying OBV to low-volume assets: The indicator loses reliability when applied to assets with irregular or thin volume.

4. Choppy markets: In sideways markets, OBV can generate false signals due to lack of clear volume flow.

🧠 Final Thoughts

On Balance Volume is a powerful yet simple indicator that leverages the relationship between price and volume to spot early trends, confirm market moves, and warn about potential reversals. It fits well into any trading strategy that values volume as a critical component of market strength.

While OBV is not infallible and can produce misleading signals during consolidation periods, it becomes significantly more powerful when used in combination with other tools such as trendlines, moving averages, and candlestick patterns.

Understanding OBV allows traders to better interpret the underlying forces driving market moves—not just what price is doing, but why it’s moving.