Trading on Cryptocurrency Bitcoin/Etherium with ON-Balance Volume Indicator
The On-balance volume (OBV) is a momentum indicator that uses volume flow to predict changes in stock price. Joseph Granville developed the OBV metric in the 1960s. He believed that, when volume increases sharply without a significant change in the stock's price, the price will eventually jump upward, and vice versa.
The theory behind OBV is based on the distinction between smart money – namely, institutional investors – and less sophisticated retail investors. As mutual funds and pension funds begin to buy into an issue that retail investors are selling, volume may increase even as the price remains relatively level. Eventually, volume drives the price upward. At that point, larger investors begin to sell, and smaller investors begin buying.
The OBV is a running total of volume (positive and negative). There are three rules implemented when calculating the OBV. They are:
- If today's closing price is higher than yesterday's closing price, then: Current OBV = Previous OBV + today's volume
- If today's closing price is lower than yesterday's closing price, then: Current OBV = Previous OBV - today's volume
- If today's closing price equals yesterday's closing price, then: Current OBV = Previous OBV
On-Balance Volume Example Calculation
Below is a list of 10 days' worth of a hypothetical stock's closing price and volume:
- Day one: closing price equals $10, volume equals 25,200 shares
- Day two: closing price equals $10.15, volume equals 30,000 shares
- Day three: closing price equals $10.17, volume equals 25,600 shares
- Day four: closing price equals $10.13, volume equals 32,000 shares
- Day five: closing price equals $10.11, volume equals 23,000 shares
- Day six: closing price equals $10.15, volume equals 40,000 shares
- Day seven: closing price equals $10.20, volume equals 36,000 shares
- Day eight: closing price equals $10.20, volume equals 20,500 shares
- Day nine: closing price equals $10.22, volume equals 23,000 shares
- Day 10: closing price equals $10.21, volume equals 27,500 shares
As can be seen, days two, three, six, seven and nine are up days, so these trading volumes are added to the OBV. Days four, five and 10 are down days, so these trading volumes are subtracted from the OBV. On day eight, no changes are made to the OBV since the closing price did not change. Given the days, the OBV for each of the 10 days is:
- Day one OBV = 0
- Day two OBV = 0 + 30,000 = 30,000
- Day three OBV = 30,000 + 25,600 = 55,600
- Day four OBV = 55,600 - 32,000 = 23,600
- Day five OBV = 23,600 - 23,000 = 600
- Day six OBV = 600 + 40,000 = 46,600
- Day seven OBV = 46,600 + 36,000 = 76,600
- Day eight OBV = 76,600
- Day nine OBV = 76,600 + 23,000 = 99,600
- Day 10 OBV = 99,600 - 27,500 = 72,100
OBV is primarily used as a confirmation tool for trends, but is also believed to foreshadow price reversals because changes in volume will often precede major price changes. Based on this assumption—please read the OBV Limitations section below for more on this topic—the OBV indicator is used in three primary ways: confirmation, divergence and breakouts.
OBV should rise when price is rising, and fall when price is falling. This helps confirm the current price direction is likely to continue. Since prices move in waves, OBV will also typically reflect this. Use trendlines to indicate the current direction in both the price and OBV.
Since OBV can confirm price trends, it can also warn when price is about to change direction. Divergence is a warning signal, and occurs when the price is trending higher but OBV is either flat or dropping overall, or when the price is falling but OBV is flat or rising overall.
If the price trend is up, and OBV is now dropping (bearish divergence), take a short position when the price breaks below its current trendline. Place a stop loss above the most recent swing higher in price. Hold the trade for as long as OBV confirms it, and the price is trending lower. Exit if the price breaks above its trendline.
If the price trend is down, and OBV is now rising (bullish divergence), take a long position when the price breaks above its current trendline. Place a stop loss below the most recent swing lower in price. Hold the trade for as long as OBV confirms it. Exit if the price breaks below its trendline.
OBV is a simple running total of up day (added) and down day (subtracted) volume. If OBV is moving with price it confirms the current trend. Divergences between OBV and price indicates the price may be due for a reversal. Using trendlines can aid in spotting divergences and trading opportunities. OBV can also help forecast breakout directions in price. OBV is not without its faults though. Volume spikes can skew the indicator, making objective analysis more difficult. Also, while it may appear that OBV often leads price, this is often simply a case of searching for evidence we wish to find. The OBV can be used to trade any asset in theory and its application is relevant when trading cryptocurrencies. However, the OBV should never be used alone as it is only a complimentary tool that must work in conjunction with other instruments.
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