Introduction
On-balance volume (OBV) is a technical trading momentum indicator that uses volume flow to predict changes in stock price. The On-balance volume (OBV) is designed to project and predict major price movements in the market by looking at the consistency of the change in balance volume against the change in price. The On-balance volume (OBV) is also often used to spot whales or large investors that can influence the market through spikes of volume. Joseph Granville first developed the OBV metric in the 1963 book Granville’s New Key to Stock Market Profits.
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Contents
- Goals of the OBV – On Balance Volume Indicator
- On-Balance Volume (OBV) for Beginners
- Feasibility of the On-Balance Volume (OBV)
- How to use the OBV
- Trading the OBV
- Pros and Cons of OBV
- Analysis of OBV
- Conclusion
- Infographic
Goals of the OBV – On Balance Volume Indicator
The goals of this article is to address certain Frequently Asked Questions regarding the OBV such as:
- What is OBV volume indicator?
- How to identify divergence with the OBV volume indicator?
- How to draw the relationship between volume and price?
- How to judge the positive and negative relationship between price and volume on up days or volume on down days ?
On-Balance Volume (OBV) for Beginners
The OBV is a simple volume indicator that is suitable for traders of all levels of technical analysis so long as they understand the rules and theories of divergence trading with volume.
It is also a simple and effective volume indicator on its own and allows beginners to have a simpler trading system as it has proven to be effective on its own.
Furthermore, the OBV can be a good addition to trading set ups that lack the ability to detect volume as well as buying and selling pressure in the market.
Feasibility of the On-Balance Volume (OBV)
The On-balance volume (OBV) utilizes divergences between the price of the security and the balance volume on the indicator to identify market inconsistencies and therefore pinpoint significant underlying buying and selling pressure in the market.
By considering the balance volume of the security, the trader is able to trade with the momentum, and if not, trade the divergence in the market.
This allow traders, especially the beginners, to attain a foothold in the market by being one step ahead of many other investors simply by inferring from the balance volume of the security.
As a result, it also grants traders to be be the first few in a relatively big price movement, allowing them to catch and ride huge buying and selling pressure in the market.
How To Use The OBV
To understand and use the OBV volume strategy, first of all traders must master and be proficient in the basics of trading, which is technical analysis.
Technical analysis mastery includes the fundamentals, in this case, mainly the understanding and applications of support and resistance as well as price action interpretation. Next, a trader must be confident in inferring the information of the balance volume from the OBV volume indicator. Lastly, the trader also has to be technical in spotting and applying divergence to real situations.
However, besides these skills, other general skills such as risk management and trade management is good to have. Fortunately, the essence of these trading skills were incorporated to this OBV volume trading strategy by means of risk reward model calculation and trail stops.
In addition, there are certain soft skills required to read and apply the OBV. These skills are identifying and comparing the trends as well as determining the positive and negative relationships between the price of the security and the balance volume using the indicator OBV.
Positive or negative relationships between the on balance volume and the price typically means if the price is following the trends of the volume on up days or following the trends of the volume on down days.
Trading The OBV
To trade the OBV, first identify the area of divergence on the charts with the help of trend lines, hence determining if the volume and price is in a uptrend or a downtrend.
Next, draw the most recent support or resistance depending on the direction, if it is a bullish or bearish divergence signals.
Subsequently, wait for price to bounce of the support and resistance line and prepare to enter the trade based on a pending order above or below the closing price, while following the flow of the direction.
The stop loss is determined by placing the order slightly above or below the support or resistance level before the execution of the pending order, thereby allowing some margin for price fluctuations, preventing early stop out. Once executed, apply trail stop at every new support or resistance level made by the price movements of the security, until stopped out, thus taking profit.
Pros and Cons of OBV
The pros of using the OBV are that it is able to pinpoint and identify a breakout before it even started. In addition, the OBV is able to increase the probability of winning utilizing divergences, although sometimes against the trend as divergence is an advance technical analysis technique. Finally, the OBV is able to confirm the trade by cross referencing the volume to the price of the security.
However, the OBV volume strategy is heavy reliant on the basic fundamentals of technical analysis, being a disadvantage to those who use fundamental analysis. Because the OBV volume strategy utilizes divergence style of trading, it will filter out many trades in the chart, causing a low frequency in terms of opportunities. Lastly, the perspective provided by the OBV volume strategy is limited since it only takes into account of the volume.
Analysis of OBV
To find out the profitability of the OBV trading strategy, we decided to do a back test based on the past 10 trades from 21 AUG 21 on the H4 timeframe.
The rules for entry will be the same as what was mentioned above. We will be back testing this throughout 3 types of trading vehicles, namely, EURUSD for forex, US30(DJI) for stocks and BTCUSD for cryptocurrency.
For simplicity, we will assume that all trades taken have a risk of 1% of the account.
Definitions: Avg Risk reward ratio= ( Total risk reward ratio of winning trades/ total no. of wins)
Profitability (% gain)= (no. of wins* reward)- (no of losses* 1) [ Risk is 1%]
An example of the application of the strategy is as shown:
For the Backtest results, trades with blue and yellow zones indicate an overall win with the blue zone as reward and the yellow zone as the risk taken. As shown in our backtest, the win rate of this strategy for EURUSD (Forex) is 60%, US30 (Stocks) is 70% and BTC (Crypto) is 60%.
The average risk reward ratio of this strategy for EURUSD (Forex) is 2.12 US30 (Stocks) is 1.97 and BTC (Crypto) is 2.34.
The profitability of this strategy for EURUSD (Forex) is 8.70, US30 (Stocks) is 10.79 and BTC (Crypto) is 10.04.
Conclusion
In conclusion, the OBV proves to be a reliable volume indicator for all classes of traders. It is able to deliver good win rate, risk to reward ratio, and also profitability. In the view of technical traders, the OBV is capable of utilizing advance techniques such as divergences and generating an outstanding performance simply on its own. Not to mention, the OBV also provides a good starting point in anyone’s forex journey as it is able to pick out intervention by whales via discrepancies in volume, therefore allowing traders to be on the safer end most of the time by aligning with the trend. This is one of the main reasons why the OBV functions well as a volume indicator, to be able to capture large rewards while keeping risks at minimum. The OBV as a volume indicator, will definitely bring huge value to traders by being incorporating it into their set ups, or even jus by using the OBV as a volume indicator on its own.
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Infographic
