Why is OBV important to traders - Unveiling the secrets of trading volume

Reliable price trends require confirmation from trading volume, but effective volume analysis tools are limited. Among the options, On Balance Volume (OBV) is a significant indicator that helps traders verify accumulated buying and selling pressure, confirming price trends or signaling potential reversals with an accuracy that is hard to estimate.

Origin and Basic Principles of OBV

Where does it come from? Who invented it?

The On Balance Volume indicator was created by Joseph Graniville, who introduced the concept in his book Granville’s New Key to Stock Market Profits in 1963. Granville firmly believed that trading volume is the hidden primary driver behind price movements, leading him to develop this indicator.

What exactly is OBV?

OBV, or On Balance Volume, is a volume-based indicator within the Momentum Indicator group. It is calculated as a cumulative sum of volume that is adjusted upward or downward based on the closing price direction.

The working principles are as follows:

• Closing price higher than previous (): Add the current volume to the cumulative total, increasing OBV.
• Closing price lower than previous (: Subtract the current volume from the cumulative total, decreasing OBV.
• Closing price unchanged )(: OBV remains the same, with no adjustment.

This mechanism allows traders to track the remaining accumulated volume in an asset and observe the trading behavior of large players who often release massive trading volumes.

How to Calculate On Balance Volume Step-by-Step

) Basic formula

The calculation of OBV uses the following formulas:

• OBVt = OBVt-1 + Volumet ### when closing price (t( > closing price )t-1()
• OBVt = OBVt-1 - Volumet ) when closing price (t( < closing price )t-1()
• OBVt = OBVt-1 + 0 ) when closing price (t( = closing price )t-1()

Where:

• OBVt = accumulated volume at current time
• OBVt-1 = accumulated volume at previous time
• Volumet = volume during the current period

) Real-world calculation example ###GOOG, Daily(

Plotting OBV alongside the price shows that the OBV trend often confirms the price direction and can also signal potential reversals before they occur.

Reading OBV Signals for Smarter Trading

) Uptrend Signal - Confirming an Increasing Trend

• Asset price rises along with rising OBV = confirms strong bullish momentum
• Price rises but OBV increases less = warns that the uptrend may be ending

Downtrend Signal - Confirming a Decreasing Trend

• Price declines with a rapid decrease in OBV = confirms ongoing bearish strength
• Price declines but OBV decreases less = warns that the downtrend may be ending

OBV Divergence - Reversal Signal

The most critical signals occur when price and OBV diverge:

• Bullish Divergence: Price makes new lows, but OBV does not make new lows = weak downtrend, potential reversal upward
• Bearish Divergence: Price makes new highs, but OBV does not make new highs = weak uptrend, potential reversal downward

Applying OBV in Trading Strategies

1. OBV + Moving Average ###MA(

Combining OBV with EMA or SMA helps identify entry points more consciously:

Example: JPYUSD, 1H Chart

When observing JPYUSD in a downtrend below the EMA 25 consistently, with OBV decreasing steadily, it confirms a strong downtrend. However, when OBV stops making new lows )Divergence( while the price begins to attempt an breakout above EMA25, it signals a buy opportunity. Traders can set stop-loss at the previous low.

) 2. OBV + Bollinger Bands

Using Bollinger Bands helps confirm reversal points at contact zones:

Example: MSFT, Daily Chart

Previously, Microsoft stock made higher highs, with OBV also reaching new highs, confirming a strong uptrend. When OBV begins to diverge and fails to make new highs while the price touches the upper Bollinger Band and then drops with a large red candle, it signals a low-risk short entry. Place stop-loss at the previous high.

Important Note - OBV is Not a Miracle Cure

Relying solely on OBV carries risks of false signals because it is based only on volume. Combining OBV with other trend indicators like MA, Bollinger Bands, or RSI significantly improves trading accuracy.

Price movement must be accompanied by high trading volume. Learning to read OBV well helps traders distinguish the strength of trends in detail and avoid potential reversals that could lead to losses.

Summary

On Balance Volume (OBV) is not just an indicator but a lens into the market’s psyche. It reveals what large players are doing and how strong the buying or selling pressure is. Deep understanding of OBV enables traders to make more confident decisions, whether confirming trends or detecting reversals ahead of others.