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On Balance Volume; Building a Better Mousetrap It has been said that if price were a train, then volume would be the steam that makes it go. That is to say, the pressure of the steam must change before the train speeds up or slows down. On Balance Volume (OBV) is an excellent tool for measuring this steam. It has proved to be one of the best leading indicators of price movement and is invaluable in providing insight regarding accumulation and distribution. On Balance Volume was originally created by Joseph Granville. It reflects a running total of volume as reflected by a change in closing prices. When the closing price is higher than the day before, the volume for that day is added to the running total, when it is lower, the volume for that day is subtracted from the running total. The short fall of on balance volume is that it generalizes. The change in price is irrelevant and only the direction of change is taken into consideration for the calculations. To overcome this short fall we need to account for where the price is headed in relation to the total price movement (highs and lows) before we attribute any volume to it. When we do this, the effectiveness of this indicator greatly increases. Look at the chart below of AMSC. The top window represents price. The middle window (red indicator) is where On Balance Volume is calculated Granvilles' way and the bottom window (blue indicator) is calculated taking into account all price movement and apportioning volume accordingly. Comparison of traditional On Balance Volume and improved On Balance Volume
Notice in the chart above how the price peaks on September 14th , as indicated by the yellow vertical line. Then on September 19th the On Balance Volume exceeds its last peak, giving promise of rising prices to continue. The “enhanced” On Balance Bolume method though, peaked the same day as the price and has started to fall, giving a clear warning that the price indeed, is about to change direction. Lets try one going in the other direction. Lets see how we can get an early detection of rising prices. Look at the chart below of AMSG.
Notice how the price bottoms out on January 9th, as indicated by the yellow vertical line. At this point, Granvilles' On Balance Volume is still in the hole. The enhanced On Balance Volume however, is in the process of creating a second higher trough, creating a convergence between On Balance Volume and price, indicating an upward breakout. Often times this enhanced method of calculating On Balance Volume will run concurrent with Granvilles' method, but when the market appears to be indecisive, it is less likely to give reason for hope where hope doesn’t exist and is more likely to identify a positive change in direction when that change is not apparent as shown above. How can you enhance your On Balance Volume indicator like the one above? First, you need charting software that will allow you to build your own indicators, such as Amibroker charting software. I have found it to be a great value. You can check it out for yourself at http://www.amibroker.com Then you need to calculate the following information. Formula for improved On Balance Volume Cumulative total of (volume * ((high-open) / (high-low))) - Cumulative total of (volume * ((open-low) / (high-low)))
What we are doing here is assigning a percentage of the volume to upward and downward movement based upon the percentage of price movement in the same direction. To build this indicator using the Amibroker language, you can paste the following into your indicator window:
myobv=Cum(V*((H-O)/(H-L)))-Cum(V*((O-L)/(H-L))); Graph2=myobv; Graph2Style=1; Graph2Color=6;
On Balance Volume deserves a much more in-depth discussion than is presented here and understanding volume is only one aspect of successful trading. The purpose of this page is to show how we can take a tool and get much more out of it to gain an unfair advantage that will allow us to compete successfully against other traders! If you would like to learn more secrets to profitable trading, then enter your name and email address below and we'll be glad to share other trading tips and resources with you.
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