According to Charles Dow's volume theory, volume should align with price trends—rising during uptrends as prices increase and during downtrends as prices decline. This volume-price correlation confirms trend strength. Over time, research led to the development of On Balance Volume (OBV), a tool measuring cumulative buying/selling pressure by adding volume on up days and subtracting it on down days. Created by Joe Granville, OBV helps confirm trends and spot divergences.
Table of Contents
On Balance Volume (OBV) Calculation
OBV is calculated as follows:
- If today’s close > yesterday’s close: Add yesterday’s volume to today’s.
- If today’s close < yesterday’s close: Subtract yesterday’s volume.
- No change: If closes are equal.
The OBV line reflects the cumulative total, with its direction being more critical than absolute values.
Trading Rules
1. Non-Confirmation of Uptrend
Occurs when price makes a higher top but OBV fails to follow. Signals weakening uptrend due to lack of volume support.
2. Non-Confirmation of Downtrend
Price breaks lower, but OBV doesn’t. Indicates declining selling pressure, hinting at a potential trend reversal.
3. Advanced Breakout
OBV breaches a prior top before price does. Suggests strong volume momentum, often preceding a price breakout.
4. Advanced Breakdown
OBV breaks a prior bottom before price. Indicates intense selling pressure, often leading to a price breakdown.
Conclusion
Use OBV with:
- Trendlines: Align OBV and price trends for confirmation.
- Daily charts: Correlate with closing prices.
- Other indicators: Combine with tools like Stochastic Oscillator for stronger signals.
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Frequently Asked Questions (FAQs)
What is OBV?
OBV measures buying/selling pressure by cumulatively adjusting volume based on price movements.
How does OBV work?
It adds volume on higher closes and subtracts on lower closes, creating a running total (OBV line) to reflect market momentum.
Can OBV predict breakouts?
Yes, advanced breakouts/breakdowns in OBV often precede price movements, offering early signals.