On Balance Volume (OBV)

This indicator was developed by J. Gransville in the early 1960's. The premise of this simple indicator is that volume comes before price. By adding the volume of a time when the close is up (when the share price is up over that time period) and subtracting the volume of a period when the close is down it is possible to define the OBV. The technical analyst will look for divergences or confirmation by comparing the price chart of the stock with the OBV.

Application

The actual numbers derived from the OBV calculations are not that important, it is the trend direction that we are more interested in. Indeed, the OBV values will differ depending on how far back you go for the data. The OBV trend line should follow in the same direction as the price trend, following the stock price up in an uptrend, and, if the stock is in a downtrend, the OBV line should do the same. A trend reversal may be possible if the OBV line shows a divergence from the price trend.

OBV will show buying or selling pressure, that is if volume is flowing into, or out of, a stock. When there is consistently increasing buying pressure, the price is almost certain to continue going up. The premise is that money from experienced institutional traders can be seen flowing into the security by a rising OBV. When the public then realises that a move is occurring and buys the stock, both the stock price and the OBV will forge ahead. OBV breakouts normally precede price breakouts, so OBV trend line breaks are important, an upside trend break is a buy signal and a break to the downside is a sell signal.

Example

The chart below is of Felix Resources (FLX) from June to October 2006. This first example will highlight what is meant be confirmation.

As you can see in the above chart, as the share price is continuing to reach new highs, (highlighted circles) so to does the OBV indicator, thereby confirming the price increase.