On Balance Volume, or OBV, is a technical trading indicator that uses volume flow to predict changes in price action. As one of the oldest and most popular volume indicators, OBV provides unique insights into emerging trends, the strength of moves, and potential reversals in the market.

What is On Balance Volume (OBV)?

On Balance Volume is a technical trading momentum indicator that uses volume flow to predict changes in asset price.

on balance volume chart

First developed by Joe Granville in the 1960s, OBV is based on a simple, intuitive assumption – volume precedes price. In other words, OBV operates on the principle that volume changes in an asset can indicate early shifts in supply and demand, which then drive prices either up or down.

The OBV indicator aims to make volume data more readable by converting raw volume figures into a cumulative total that better shows overall shifts. It tracks whether volume on any given day is ‘positive’ or ‘negative’ relative to closing price.

Positive volume days add to the running total, while negative days subtract from it. The result is a OBV line that oscillates above and below a baseline and generally trends upward, downward or sideways over time along with price.

How It Works

The on balance volume calculation is fairly simple. Here are the key steps:

  1. If the closing price is higher than the prior close, that day’s volume is considered positive, and added to the running total OBV.
  2. If the closing price is lower than the prior close, that day’s volume is considered negative, and subtracted from the running total OBV.
  3. If closing price is equal to the prior close, no volume is added or subtracted from OBV.

That’s it! The resulting OBV line is a running cumulative total of volume weighted for direction each period. As noted above, upward sloping OBV reflects positive momentum, downward negative momentum, and flat OBV shows indecision.

OBV Formula

The OBV formula in its basic form is:

OBV = Prior OBV + Current Period’s Volume (if Close > Prior Close) OBV = Prior OBV – Current Period’s Volume (if Close < Prior Close) OBV = Prior OBV (if Close = Prior Close)

Where:

Prior OBV = The prior period’s OBV total Current Period Volume = The volume for the current period Close = The closing price for the current period Prior Close = The closing price for the prior period

So OBV provides a running sum of volume based on daily price change. Positive volume days accumulate, while negative days subtract from the indicator.

This simple calculation allows traders to easily spot buying and selling pressure in an asset based on price-adjusted volume flow. Let’s now look at how to actually put the OBV indicator to work.

How to Use OBV Indicator in Forex Trading

on balance volume settings

On Balance Volume is a versatile indicator used by short-term traders and long-term investors alike. Let’s examine some of the key ways the OBV line can be applied to forex trading:

1. Identify Trend Strength

The most basic use of OBV is to gauge the strength or weakness of a trend. Recall that OBV oscillates with net volume flow over time.

  • Uptrends are marked by a rising OBV line, as positive volume accumulates. The speed of OBV’s rise signals the strength of the uptrend. Faster rises reflect stronger bullish momentum.
  • Downtrends are marked by a falling OBV line, as negative volume is subtracted from the total. Faster OBV declines signal a stronger bearish trend.
  • Flat OBV lines reflect non-directional, trendless trading ranges. Volume is choppy and alternating between positive and negative.

Monitoring OBV direction and slope allows traders to quickly assess the character of any trend or trading range.

2. Confirm Trend Changes and Reversals

Shifts in OBV direction can act as an early warning signal of an impending trend change or reversal. Since volume leads price, OBV will usually change course before the actual asset price does.

For example, if OBV is rising but then begins to flatten and fall, it indicates bullish momentum is waning. Traders would prepare for a potential trend reversal by lightening up bullish positions. The opposite applies for a topping OBV indicator, which would precede a downtrend reversal.

Divergences between OBV and price are especially noteworthy, as volume tends to lead price. If OBV is making new highs but price fails to follow, it signals underlying weakness in the uptrend. Traders would watch for the uptrend to reverse.

3. Spot Trend Exhaustion

A flattening or flat OBV line following a sustained price trend is a sign of trend exhaustion. Flat OBV reflects a leveling off of buying or selling pressure after a period of vigorous activity.

For example, if OBV flattens following a strong uptrend, it signals the bullish momentum that previously propelled prices higher has diminished. The uptrend is fatigued and at risk of reversal. Traders may book profits on bullish trades.

A flat OBV following a downtrend indicates bearish momentum has faded. The prior decline is likely exhausted and due for a counter-trend bounce.

4. Trade OBV Breakouts

Since OBV tends to lead price, breaks above or below key OBV levels can identify emerging trends early. Traders can enter new long positions on upside OBV breakouts above prior highs or peaks. Short setups would focus on OBV breakdowns below key support.

Stops are placed on the opposite side of the breakout point to control risk on the trade. OBV breakout strategies aim to capitalize on volume-confirmed trend continuations. The surge in OBV confirms the new direction.

5. Use With Other Indicators

OBV is often combined with price-based indicators to look for confirming signals. For example, bullish OBV divergences that see OBV break out while price holds above key moving averages could flag an upside breakout opportunity.

Overbought/oversold oscillators like RSI, stochastics, CCI etc can be added to identify exhausted OBV trends. OBV reversal signals are stronger when coupled with extreme oscillator readings.

On Balance Volume Trading Strategies

Now let’s examine some high probability OBV trading strategies you can utilize when analyzing the markets:

OBV + Moving Averages

A simple OBV system uses the direction of the indicator relative to key moving averages to define the trend. For example:

  • Long trades – OBV is above its 21-day exponential moving average (EMA)
  • Short trades – OBV is below its 21-day EMA

Moving average crossovers can also identify trend reversals. For instance, if upside breakouts are traded, a downward OBV crossover below its EMA signals an exit. Stop losses on positions would be placed on the opposite side of the EMA.

OBV Divergences

This strategy looks for divergences between OBV and price to catch reversals early. The steps are:

  1. Identify trending price swing highs/lows on the chart.
  2. Draw trendlines between the swing points.
  3. Look for OBV to make higher highs/lower lows versus price at swing points.
  4. The divergence signals waning momentum and potential reversal ahead.

Traders would go long on bullish divergences with OBV above its EMA, and short bearish ones with OBV below its EMA. Set stops on other side of EMA.

OBV Breakouts

This breakout method is straightforward:

  1. Identify previous OBV highs or lows as potential breakout levels
  2. Buy when OBV breaks above resistance with increased volume. Sell when OBV breaks below support.
  3. Place protective stops on opposite side of the breakout point.
  4. Book partial profits at a risk/reward ratio like 1:1 or 1:2. Move stop to breakeven to lock gains.

The increased OBV momentum fueling the breakout signals continuation of the emerging trend. Volume-based breakouts tend to be more significant than price breaks.

OBV + Oscillator for Exhaustion Signals

An exhausted, overextended OBV line signals impending reversal ahead. Oscillators like RSI can boost signals.

  1. Identify trending OBV line reaching overbought/oversold extremes (e.g. above 80/below 20 on RSI).
  2. Look for negative oscillator divergences to confirm OBV exhaustion.
  3. Entry signal is reversal candlestick pattern on reversal back below/above the 80/20 levels.
  4. Stop loss on opposite side of the 80/20 threshold.

This rules-based approach allows traders to profit from OBV trend reversals with precision and confirmation from momentum oscillators.

The Benefits of Using OBV Indicator in Forex

On Balance Volume is a straightforward yet powerful indicator. Here are some benefits of using OBV analysis in forex:

  • Simple to calculate and interpret – OBV just sums volume based on direction
  • Volume precedes price – early warning of trend changes
  • Signals accumulation/distribution – rising OBV reflects increased buying pressure
  • Confirms breakouts & reversals – OBV divergences pinpoint loss of momentum
  • Works on all timeframes – identifies momentum from short to long-term
  • Objective – volume reflects real market activity, not just price opinions
  • Combines with other indicators – use OBV with oscillators, moving averages etc.

Used properly, OBV can provide unique and reliable trading signals across all markets and timeframes. Let’s now cover some tips when analyzing OBV.

Tips and Notes for Using OBV

Here are some key pointers to keep in mind when using on balance volume in your forex trading:

  • OBV works best with very liquid, actively traded pairs like EUR/USD with true volume data. Use with caution on exotic pairs.
  • Trending prices tend to see sloped OBV lines. Ranging prices have flat OBV lacking clear direction. Trade with the trend.
  • Watch for OBV and price divergences at swing highs/lows for reversals. Divergences flag loss of momentum.
  • Strong trends see OBV pulling away from its signal EMA with increased separation. Weak trends see OBV revert toward its EMA.
  • A flattening OBV signals potential exhaustion after a sustained trend, especially with negative oscillator divergences.
  • With breakouts, ensure OBV is making new highs/lows with expanding volume for high-probability setups.
  • OBV works on all timeframes. Use shorter timeframes like 5 or 15 mins for timing breakout entries or exits.
  • OBV tends to precede price, but other confirmations like candlesticks or momentum oscillators make signals more robust.

Mastering these nuances will help improve the accuracy of OBV analysis.

Putting It All Together

On Balance Volume is a versatile volume tool that provides unique trend and momentum insights for forex traders. Here are some key points:

  • OBV tracks positive and negative volume flow via a cumulative line that trends with price over time
  • Rising OBV marks accumulation and uptrend strength. Falling OBV shows distribution and bearish momentum.
  • OBV divergences signal waning momentum at trend turning points. Breakouts identify trend resumptions.
  • Traders use OBV direction, slope, and breakouts to assess emerging and ongoing trends and potential reversals.
  • Combining OBV with price patterns and momentum oscillators can improve the odds of profitable forex signals.

In summary, the on balance volume indicator enhances most trading strategies by incorporating volume-based trend and momentum confirmation. Give OBV a try in your forex analysis!

Conclusion

On Balance Volume is a versatile volume-based trading indicator that provides unique insights into developing trends and potential reversals. By tracking accumulation, distribution, and loss of momentum, OBV can boost most forex trading strategies.

This complete OBV guide covered everything you need to know to apply OBV analysis in your own forex trading. The key is using OBV in multiple ways – to confirm trend strength and reversal signals, time breakout entries, spot divergences, and prevent overstaying exhausted trends.

Combined with price action and momentum oscillators, OBV can significantly improve trading timing, precision and performance. Challenge yourself to go beyond just price, and add volume confirmation with OBV to your forex toolkit today.