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Interpreting volume is one of the primary activities that help traders make informed decisions. Based on volume analysis, the On-Balance Volume (OBV) indicator is an effective leading indicator that allows traders to gauge bearish and bullish sentiment in the financial markets. However, only a few traders take full advantage of this indicator.
Developed by Joe Granville in the 1960s, OBV works on the principle that volume precedes price. High volume in the direction of the price action creates convergence, thus adding reliability to directional signals. On the other hand, an increase in volume in the opposite direction creates divergence, informing traders of a conflict or indecisiveness in the market. The volume theory emphasises that even if the bulls can push the prices higher, the lack of buyers in sufficient numbers could lead the price to retract faster. Similarly, if there are more buyers but not enough sellers, the asset’s price is bound to rise.
The OBV indicator tallies volume in both directions. It is an easy-to-use accumulation-distribution tool that is used to confirm price trends. Notably, traders focus on the trend indicated rather than not the actual value to gauge how the markets will play out as a result of price and volume interaction. This is because OBV is a cumulative indicator, i.e., it considers previous values and the value at the start of the chosen timeframe. The slope and direction are considered more important and used by traders to strengthen their trading strategies. It helps traders:
Traders popularly set test levels based on analysis for at least a few months. This way, they ensure that the results are more relevant and accurate.
The most recent OBV value is calculated using the current volume and the previous OBV value. It is calculated in different ways, according to price action.
Current OBV = Previous OBV + Current Volume
Current OBV = Previous OBV – Current Volume
Current OBV = Previous OBV
Traders start by determining the OBV trend. Next, they compare and gauge whether the current price trend matches the OBV trend. The third step is to look for potential support and resistance levels and the price action concerning them, keeping in mind that OBV considers closing prices. Finally, changes in volume help traders speculate on the direction of the price movement with the support indicators to confirm the signal.
Some inferences traders make using OBV are:
When the on-balance volume trend line breaches its highs or lows ahead of the price, it is known as an advanced breakout, which could occur in either direction. It is considered a strong signal of an impending trend change.
Here’s a look at the most popularly used OBV trading strategies.
When the price movement indicator and volume indicator do not conform, a divergence is said to occur. Divergences are potential reversal indicators.
Using OBV with the 200-day EMA is a popular strategy that helps traders to make decisions.
Since OBV uses price direction and volume, it offers many advantages over other volume indicators, such as:
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