Volume Tutorial:
On-Balance Volume
(OBV)
The On-Balance Volume (OBV) indicator was introduced by Joe Granville in
1963. The indicator simply adds up volume that accumulates during
up-moves while subtracting volume that builds up during down-moves.
Essentially, the indicator works as follows (using daily closing bars in
this example): If the current daily session closes above the previous
session's close, today's accumulated volume is added to the OBV;
conversely, if the current session closes below the previous trading
day's close, the volume that built up in today's session is subtracted
from the OBV.
The OBV indicator can be used to confirm
an existing trend run. A rising OBV line indicates a bullish market sentiment
whereas a falling OBV line indicates a bearish mood. This follows logically
since the indicator adds volume during an uptrend while subtracting it during a
downtrend.
If dramatic changes (increases or
decreases) occur to the OBV line without being accompanied by simultaneous price
changes, this may indicate that an existing trend run will reverse course in the
near future. Dramatic increases in the OBV line during an uptrend are caused by
selling volume surges. Under such circumstances, you will notice a sharp rise
in the OBV line given a huge surge in volume added to the OBV line over a short
period of time. On the other hand, during a downtrend, you may note a dramatic
decrease in the OBV line, the result of a buying volume surge that occurs as
a huge amount of volume is subtracted from the OBV line over a comparatively
short time.
As you can see, there are similarities
between the OBV indicator and our concept of buying and selling volume
surges. During a downtrend, there comes a point where the "smart money" starts
buying at a time where the "average investor" is still selling. This may lead to
buying volume surges that over time can prompt a trend reversal to the
upside. Likewise, during an uptrend, there comes a time where the "smart money"
starts selling while the "average investor" is still buying. Evidence of this
can be seen in selling volume surges that over time are followed by downside
reversals.
Even though the OBV indicator may also
be suited to spotting probable index reversal, we strongly believe that a proper
evaluation of volume surges according to our methodology will better serve this
purpose; however, the OBV Line certainly has its value as a confirming trend
indicator. Below, we have compared a few advantages and disadvantages of the OBV
Line and the Percentage Volume Oscillator:
| OBV Line |
 |
PVO indicator |
| The OBV line does not generate absolute
values. It is therefore difficult to use it objectively for historical
data comparisons. |
|
The PVO indicator generates absolute
values, making it amenable to direct historical data comparisons (which
can be used to establish critical volume surge levels). |
| An objective evaluation of "dramatic"
increases or decrease in the OBV Line (caused by large volume surges) is
difficult. |
|
Because the PVO is an oscillator-type
indicator, it becomes easy to evaluate (and compare) various volume
surges objectively. |
| It is not easy to determine what
constitutes "high" or "low" volume activity for a given session. |
|
PVO values greater than 1 indicate high
volume (i.e., high trading activity). PVO values below 1 indicate low
volume (i.e., low trading activity). |
| By its construction, the OBV is a
cumulative indicator. It can serve well to confirm a rising or falling
trend. A rising OBV line indicates an uptrend; a falling line indicates
a downtrend. |
|
The PVO is not a cumulative indicator.
In order to use it as a trend indicator, additional analysis is
required. Generally speaking, during an uptrend, critically selling
PVO values are higher than critically buying PVO values. The
opposite applies to downtrends. |
|
