What is on balance volume (OBV) and how does it work?
The OBV indicator is a technical analysis tool to identify market sentiment. Find out how it was made, how it works, trading strategies, its limitations and how you can use the OBV indicator to trade on our platform.
What's on this page?
What is the OBV indicator?
The on balance volume (OBV) indicator is a technical analysis tool used to detect the trading volume of an asset over time. It was popularised by Joseph Granville in the 1960s. It measures the volume trend of an asset relative to its price movements and is calculated on a daily basis.
How does the OBV indicator work?
The OBV indicator is based on the principle that if an asset experiences a notable increase in trading volume, it signals increased demand for the asset that could precede a positive price movement. Conversely, a notable decrease in volume would suggest that demand for the asset has dropped and could indicate a future drop in its price.
The OBV calculates the cumulative total of an asset's volume, adding to it when the price goes up and subtracting from it when the price goes down. As such, it's seen as a consistent running total of an asset's volume.
The following formulae describe how the OBV is calculated:
- Previous OBV + Current Volume when the current close price is higher than the previous close price
- Previous OBV - Current Volume when the current close price is lower than the previous close price
- Previous OBV stays fixed when the current close price is equal to the previous close price
Imagine that a stock opens at a share price of $105. By the end of the day, it closes at $110 with a trading volume of 15,000. The next day, the asset closes at $115 with a trading volume of 10,000. This makes the OBV indicator 25,000, as yesterday's volume is added to today's figure.
If the stock then falls to $105 the next day with a trading volume of 12,000, the asset's OBV will be calculated at 13,000. This sequence continues each day, depending on the closing price of the asset.
When the asset's price is moving in line with the OBV, it may suggest that the current price trend is strong and may continue. When the price is moving in the opposite direction of the OBV, it may suggest the price trend has weakened and may reverse.
You can plot the OBV on a chart to detect possible bullish and bearish signals, similar to other technical analysis tools.
How to trade using the OBV indicator
You can trade or invest with the OBV indicator on our platform using the following steps:
- Do your research about the different markets
- Decide if you'd prefer to trade using spread betting and contract for difference (CFD) trading or investing via share dealing
- Open a live trading account or practise with a free demo account
- Select your market
- Choose your position size, place the trade and manage your risk
- Monitor your position
Research your market
Share dealing is a popular way to invest using the OBV indicator. When share dealing, you purchase physical shares of a company, typically with a view to longer-term investing rather than trading. When investing using share dealing, you can use OBV to identify ideal entry and exit points for your investment by tracking the measure over time. When share dealing, your risk is limited to the sum you initially invest to buy the stock you hold.
You can trade using leverage with spread bets and CFDs. You'll place an order based on your market assumption that a stock's price will rise or fall, without actually owning physical shares. You can also take a position on shares over the short or medium term, and go long or short on the shares you're interested in.
Trading via spread betting and CFDs
Spread betting has certain advantages. By opting for spread bets, you have the freedom to determine the amount you want to trade per point movement, providing you with enhanced control over both your position size and currency exposure. Traders favour spread bets due to the tax-free nature of profits, along with the absence of stamp duty or capital gains tax obligations.*
You can trade using OBV through CFDs – which are leveraged products, just like spread bets. You won't own the underlying asset, but are instead placing an order on its price movement. The currency exposure and initial margin will depend on the specific contract associated with the chosen asset.
Both spread betting and CFD trading are leveraged, so you could gain or lose money quickly – including the potential to lose more than the initial deposit paid to open the position. It's useful to keep in mind that past performance isn't a guarantee of future patterns.
* Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.
OBV trading strategy
You can use the OBV with other technical analysis methods to determine entry and exit points for a trade as part of your wider trading strategy. These are a few of the most popular OBV indicator trading strategies:
A rudimentary way of using the OBV is by drawing a trendline along your OBV path. When the line is trending upward, it may suggest upward pressure that you can use to place a buying position. When it's trending downward, it may suggest downward pressure, so you might enter a selling position.
You can look at the price movement and the trendline of the OBV to identify a divergence. If the price is moving up but the OBV trendline is moving down, it may signal a bearish divergence where the price is likely to come down again. A bullish signal may be occurring if the price is falling while the OBV trendline is rising.
You can mark support or resistance levels using the OBV as the basis to identify breakout points for a stock. When the OBV breaks above a resistance point, you may want to consider a long position. If it breaks through a support, you might consider a short position.
OBV moving average
You can calculate a moving average using your OBV figures much like you would use a moving average on regular stock prices. When the OBV rises above its moving average, it may suggest bullishness that you can use to buy the asset. When the OBV falls below its moving average, it may suggest a selling trend that would allow you to enter a selling position.
Limitations of the OBV indicator
There are several limitations to the OBV indicator that you should be aware of before using it to trade. It's important to use the OBV alongside other technical and fundamental analysis tools before trading.
Not suitable for day trading
As the OBV is calculated at market close, it's not that useful for a day trader to identify buying and selling signals throughout the day.
The OBV is a leading indicator. This means that while it can produce early signals, it's not always clear what those signals mean. Announcements that shock the market can accordingly produce sharp rises in volume, throwing off the indicator.
Applicability across markets
Thanks to its dependence on volume, the OBV might only be effective when assessing more popular assets, like stocks with a high market cap. It also ignores other factors that might dictate market sentiment, like stock news or updated economic figures.
On balance volume summed up
- The on balance volume (OBV) indicator is a technical analysis tool used to detect market sentiment based on an asset's trading volume over time
- It is a running total that adds or subtracts an asset's trading volume each day to determine trends against that asset's price direction
- Limitations of using OBV include its lack of suitability for day trading and the potential to give false signals
- You can use the OBV on our platform to invest through share dealing or trade via spread betting and CFDs
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