There are instances that traders manage to predict the trend of the certain stock, but the problem lies on the consistency and/or the confirmation of the forecast. In this case, it is recommended to use on-balance volume as a cumulative indicator, whereas the buying and selling pressure is gauged.
In early 1960’s, Joseph Ensign Granville, a financial writer and renowned investment seminar speaker, developed the concept of “on balance volume.” Included in his book entitled Granville’s New Key to Stock Markets, Mr. Granville found a way to measure positive and negative volume inflows. As a momentum indicator, he explained that when volume increases sharply without a significant change in the price of a specific asset and/or stock, eventually, the price will go up.
On-Balance Volume can show if the volume is pushing up or down, but first of all, you need to comprehend how it works, its rules and the support it can provide on your trading decisions. Below is an illustrative example of a trading platform which uses OBV as a momentum indicator.
There are three basic ideas involved in using OBV. First, when the closing price today is higher than yesterday; you can calculate the current OBV through adding previous OBV plus today’s volume. Second, when the closing price day today is lower than the closing price yesterday, then you have to subtract the previous OBV with the current volume. Third, in times that the closing price for today is the same with the closing price yesterday, then the current OBV will be the same as the previous OBV.
For instance, the closing price of Alibaba last September 30 was 105.94 and then when the market opened on October 3, the closing price was 105.39. To know the current OBV, subtract the current volume from previous OBV. That would be 75991-12671 and the current OBV is 63320.
If the closing price today is higher than the closing price yesterday, it means that the volume is up. When the volume on up days outpaces volume on down days, then the OBV will eventually go up. If the OBV rises, it means there is a buying pressure.
If the closing price today is lower than the closing price yesterday, it apparently means that the volume is down. When the volume on down days outpaces volume on up days, there’s a huge tendency that the OBV will decline. If the OBV drops, then it will signal for a selling pressure.
Therefore, OBV can be used to determine the general trend identification of a stock and to predict the price action after divergences. The strong correlation between the volume and the price will help the trader in identifying the confirmation of the trend.
This indicator is valuable for traders who value the buying and the selling pressure during the trading process. Since OBV can give absolute buying and selling signal, this is also recommended as an additional tool in conducting technical analysis. The changes of the price patterns matters in identifying the future price changes, and OBV is one of the best tools in this area.