Indicators  |  MAY 1999

On-Balance Volume by Stuart Evens

On-Balance Volume by Stuart Evens What do technicians look at in order to qualify the significance of a trend? One key element is volume, in that high volume in a trend indicates that large players may be involved. The theory goes that large traders are better informed, so the trend is likely to continue. How can you track volume? Does a volume-based indicator help the analyst and trader? Take a look. One of the better-known technical indicators to track volume is the on-balance volume (OBV). The OBV line is simply a running sum calculated by adding or subtracting the security’s daily volume from the previous day’s OBV value, depending on whether the security‘s closing price was up or down for the day. The OBV line is usually plotted as a line above or below the price bar graph of the security (Figure 1). Two popular uses of this indicator is to watch for confirmation of the price trend by the OBV line, indicating that the volume is increasing in the direction of the trend, and forewarning of a trend reversal by the divergence between the direction of the OBV line and the price trend. Let’s look at the initial method and theory. OBV PHILOSOPHY OBV creator Joseph Granville first presented the concept of OBV in Granville’s New Key To Stock Market Profits. In developing this tool, Granville started with the premise that market participants are divided into smart money entities and the general public. He assumed that the smart money was able to accumulate stock at lower prices compared with that of the public based on their having better information. During a bull market, Granville theorized, smart money initially bids prices up and then only participates in the buying for the first-half to two-thirds of the move. At that point, smart money players are fully invested and are now holding for the last third of the move, planning to sell out at the top. He opined that this is just when most of the public is starting to notice the runup in prices and is buying the stock. This sets the stage for the smart money, who then dumps stock to the public.

by Stuart Evens