On-Balance Volume: What You Need to Know

Investors always seek balance in their portfolios. A retirement saver might balance their assets with a 401(k) account and a Roth IRA to take advantage of different tax benefits. An investor can offset risky tech stocks with safer government bonds — especially when treasuries are yielding close to 5% interest rates. 

Balance is also important when looking for trade opportunities with technical analysis. Relying solely on a single indicator isn’t a recipe for success, and the best indicators use a variety of data points to reach conclusions. The on-balance volume (OBV) indicator uses price data across multiple days (or even weeks) to provide insight on the direction of trends to investors.

What Is an On-Balance Volume Indicator?

The OBV indicator is a momentum trading signal that uses the volume of buyers and sellers over a certain period to project trends. OBV can be used to help confirm the continuation of a current trend or indicate a reversal based on volume over the previous period. 

If you want to make a living trading stocks, you’ll need to understand technical trading signals like the OBV indicator. Long-term investors don’t necessarily need to be concerned with day-to-day market movements, but short-term traders must stay ahead of the trend.

How to Calculate OBV

Calculating OBV requires data to be continuously updated since it’s a cumulative indicator used over a specific time period. To calculate OBV, you’ll need a starting point. The time period needed to use OBV isn’t a set number, but the more data points you have, the more accurate the indicator will be.

The calculation goes like this: each day’s trading volume is added or subtracted from the cumulative total based on that day’s closing price. If the price is up on the day, the trade volume is added to the cumulative total. If the price closes down, the volume is subtracted from the total. The cumulative total will form a trendline on the lower half of the stock chart, which can be compared with the price trend.

The formula looks like this:

• If price is down, subtract day’s volume from previous day OBV
• If price is up, add day’s volume to previous day OBV
• If price is unchanged, OBV will be unchanged

How Does This Indicator Work?

Embarking on day trading requires data, good instincts, and a market feel. Many technical analysis tools like the Relative Strength Index (RSI) produce specific numbers, such as 100 meaning oversold or 25 being undervalued or the Simple Moving Average (SMA) uses data to produce a specific price average over a certain period, like 50 days. While the OBV indicator does spit out specific volume data points each day, the specific numbers aren’t very important when using it for signals since it’s the overall trend that matters.

The OBV is best used as a “feel” indicator. It’s not so much the daily volume numbers that matter, but the direction of the trendline produced from the calculation. 

What Does OBV Tell You?

The OBV indicator can tell you one of two things:

• If the OBV trendline matches the price trend, momentum can be expected to continue in the current direction.
• If the OBV trendline is moving opposite of the price trend, momentum could be slowing as institutional investors buy or sell shares in bulk.

On-Balance Volume Information

Here are a few examples of the OBV indicator in action:

Confirm Trends

The OBV indicator can be used to signal a continuation of the current trend pattern, regardless of the direction the stock price is moving. For example, if the OBV trendline matches the trendline of the current price, you can expect the trend to continue.

Find Divergences

One important aspect of technical analysis is detecting sentiment changes before the price follows. On-balance volume is often considered an institutional trade indicator, because its trendline often diverges from the price trend when large institutional investors enter or exit positions. Separation in the OBV trend and price trend can indicate momentum changes.

Combine with Other Indicators

OBV can be used with other momentum indicators like the relative strength index (RSI) and exponential moving averages. Combining different momentum indicators can create a clearer picture of a stock’s trend and help lower the rate of false signals.

OBV vs. Accumulation/Distribution

The OBV indicator is a momentum indicator, like the accumulation/distribution (A/D) indicator, but they reach conclusions in different ways. The OBV is a less complex formula — if the price is up, volume is added and vice versa. The A/D indicator is more frequently used to find divergences and uses a money flow multiplier to formulate its trendlines. Both can be used to identify the smart money, but the A/D indicator requires a more complex calculation.

Limitations of Using OBV

Like any indicator, OBV has its drawbacks. In choppy markets, the OBV trendline may match or diverge with the price trend, but false positives can happen, especially during particularly volatile periods. However, false positives can be limited if other indicators are used in conjunction with OBV to identify trends. 

Use OBV with Other Indicators to Find Momentum

On-balance volume (OBV) can be a useful data point when adopting a momentum trading strategy. It’s fairly simple to calculate and can be used to both confirm trend continuation or hint at reversals, if the data diverges from the current price trend. But false positives may still occur, and OBV shouldn’t be used on its own to make trading decisions. While OBV sometimes picks up what institutional traders are doing before the public, investors should always confirm multiple signals and use every available data point when making short-term trades.

Frequently Asked Questions