Forex trading requires traders to carefully study the parameters that describe the state of the market. The main parameter is the price. Its changes are the basis of trading and the clue to profit generation. There are also such important indicators as the level of volatility, liquidity, and others. However, no instrument provides as much important information as trading volume.
Tracking changes in volume is an important task for a Forex trader. It can help you to predict the emergence of a new trend in advance. One of the technical tools for monitoring this parameter is the on-balance volume (OBV). It is a popular momentum indicator used by traders to forecast price movements. In this article, you will learn how to use on balance volume indicator, how to calculate it, and how to incorporate it into your strategies.
What Is the On-Balance Volume (OBV) Indicator?
The on-balance volume indicator is a technical analysis tool developed over 60 years ago by Joseph Granville. Initially, the indicator was used to determine stock prices, but later, it was successfully used by Forex traders.
The inventor of the OBV stated that trading volume is a key factor that affects the market. He described a simple on balance volume formula that helped calculate the indicator value and draw a volume change curve.
The direction of the curve can quickly show an increase or decrease in trading of a certain currency pair, and divergences with the price chart provide even more information for analysis. Now that you know what does OBV mean, it’s time to learn how to calculate it.
OBV Formula and Calculation
Each point on the OBV curve shows the accumulated trading volume for the calculation period. To calculate it, you need to select the starting point (for example, the beginning of the day or month) and then add or subtract the values of subsequent periods. The choice of sign ("plus" or "minus") in the OBV formula depends on whether the closing price of the asset has increased or decreased. In general, the balance volume can be calculated using one of three formulas:
- OBV = OBV (prev) + current period volume (If the closing price is greater than the closing price (prev)).
- OBV = OBV (prev) - current period volume (If the closing price is less than the closing price (prev)).
- OBV = OBV (prev) (If the closing price is equal to the closing price (prev)).
Any trading platform automatically calculates the balance volume values and draws a graph, which is usually located under the asset price chart. The OBV curve most often moves synchronously with the price curve.
However, sometimes, there is a sharp change in volume without a similar change in prices. In this case, the volume can either go in the direction of the trend or against it (divergence). This may indicate a possible price change shortly.
Interpreting OBV
The next question after “What is OBV indicator?” is “How to interpret it?” When interpreting the OBV chart, it is important to understand that volume is a key market indicator and its moving indicates a change in market sentiment and potential new trends. Therefore, the on-balance volume can foreshadow two possible scenarios.
The first is trend confirmation. If, for example, buyers are confident in price growth and buy more and more, then the volume grows. In this case, the bullish trend is confirmed by a growing OBV graph. The emergence of new highs tells traders that the trend is strong enough.
The opposite situation is a divergence. For example, suppose the price trend shows a steady increase, and the on balance volume chart moves in the opposite direction. In that case, this may indicate increased selling pressure and a possible reversal.
Also, experienced traders can identify false breakouts of support and resistance lines using the OBV. To do this, you need to draw these lines on the on-balance volume chart and see if the curve breaks through these lines. If the price breakout is not confirmed on the OBV chart, most likely, it is false.
How to Use On Balance Volume Indicator
In the previous section, we looked at the main patterns of the OBV chart. Now that you understand what is on-balance volume, let's look at how it can be put into practice:
- Opening a new trade and setting a stop loss. If the OBV shows divergence with the price chart, a reversal is possible. You can open a long position on a bearish trend or a short position on a bullish trend. In the event of a reversal, you will catch the very beginning of a new trend and can make a good profit.
- Holding a position. If the on-balance volume confirms the price trend and the market continues to confidently sell or buy, this means that it is too early to close the position.
- Filtering false signals. Whether you are expecting a reversal or working on a trend, looking for false and true breakouts will help you more accurately determine future price behavior.
In addition to analyzing these obvious signals of the OBV indicator, it is also important to follow several tips that will help you form a practical and effective OBV trading strategy:
- Use the OBV together with other trend indicators and oscillators. This will help you get a clearer image of future price behavior.
- Use the OBV on timeframes from H1 and higher. On short timeframes, it does not provide accurate forecasts.
- It provides the most accurate forecasts on highly liquid pairs, such as EUR/USD or BTC/USD.
- Do not risk large amounts of money if you rely only on the OBV. The indicator can give false signals, and it is better to check them with other instruments.
- Use expert advisors that automatically analyze a large amount of data and can confirm the OBV predictions. For example, you can use the best Forex robots to trade more effectively and improve your strategy.
These tips will help you more accurately predict the price using the OBV and better understand the market as a whole.
Advantages of Using OBV
The on-balance volume indicator has been actively used in Forex, the stock market, and some other financial markets for over half a century. Such popularity and longevity would be impossible without obvious advantages:
- Ease of use. The OBV has a simple formula and a clear meaning. This makes it an ideal tool for both beginners and experienced traders.
- High efficiency. Trading volume has a significant impact on the market, and its changes provide fairly accurate forecasts.
- Multifunctionality. The OBV can be integrated into various strategies based on a trend reversal or its continuation.
These features of the tool, as well as its default presence in trading terminals, make it one of the favorite tools of traders.
Potential Pitfalls and Limitations of OBV
The simplicity of the OBV Forex determines its unambiguous interpretation and ease of use. At the same time, this simplicity sometimes prevents the indicator from giving accurate predictions. The main limitations include:
- The trading volume of a specific currency pair is difficult to assess unambiguously. Data may vary across platforms. Therefore, the OBV may not provide the most accurate forecasts.
- The OBV only shows the general trend of growth or decline in volume and does not take into account other market factors. In this regard, it is important to confirm signals by other, more complex tools.
- Sharp changes in volume may not correlate with price changes and give false signals.
- Since the OBV is a fundamental instrument, it does not provide information about what is actually happening on the market. At any given time, it only shows a forecast.
Understanding these limitations will complement the knowledge of how to use OBV and help to manage your risks.
Integrating OBV with Other Indicators
Despite its fundamental nature and connection with the main market parameter, the on-balance volume indicator is more often used to confirm a trend or other signals. So, when the market is in a strong bullish or bearish trend, market participants with open positions often check it to make sure that the volume is moving in the same direction.
Since the OBV is a leading indicator, it is often supplemented with lagging indicators. Together, they provide a holistic picture and help to better assess the market situation. Also, other momentum indicators are sometimes used together with the OBV. A classic example is the Moving Average Convergence/Divergence.
Integration with other tools is a fundamental part of a trader's work. No technical instrument, even the most advanced, can guarantee a 100% accurate forecast. Therefore, they all need to be checked and supplemented. Learning various indicators together with personal experience will help you create your toolkit and successfully use it in your strategy.
The Bottom Line
The OBV is a technical analysis tool that was introduced into trading practice in 1963. Since then, it has been actively used in the stock, currency, and cryptocurrency markets. The instrument measures the trading volume and compares it with the asset price. Thanks to this, it is possible to draw conclusions about market sentiment and potential price changes. OBV is one of the simplest tools. It does not provide much specific information but is useful in conjunction with other technical tools. Undoubtedly, every trader should know how to use the OBV indicator.
