On-balance volume (OBV) is a momentum indicator. In general terms, its calculation relates volume to price change. Developed by Joe Granville in the early 1960s, OBV provides a running total of market volume and shows whether this volume is flowing into or out of a given commodity, bond or stock based on changes in the market’s price.
OBV attempts to detect when a financial instrument is being accumulated by a large number of buyers or sold by many sellers. It is based on the concept that volume is the driving force behind the market. Therefore, OBV is designed to project when major moves in the markets would occur by measuring the positive and negative volume flow. By analyzing OBV, traders may project when major moves in the markets will occur.
Often, OBV is described as an attempt to determine the actions of the “smart money” in the market. Smart money typically is used to refer to market participants who are either large, well-capitalized traders or commercial entities with a broad understanding of the underlying commodity or “inside” information on the market fundamentals.
While it’s impossible to say precisely whose positions are reflected in the OBV indicator, it’s reasonable to assume that it reflects the behavior of the majority of the positions in the market. If we accept that, then we can accept the premise that OBV provides a reliable gauge of future market bias.
On-balance volume is calculated by adding the day’s volume to a cumulative total when the security or futures contract price closes up, and subtracting the day’s volume to that cumulative total when the price closes down.
- If today’s close is greater than yesterday’s close then: OBV = Yesterday’s OBV + Today’s volume (considered up volume). Up volume occurs when a market finishes a day of trading at a level higher than its previous close, meaning that the trading volume for the day was more bullish than bearish.
- If today’s close is less than yesterday’s close then: OBV = Yesterday’s OBV – Today’s Volume (considered down volume). Down volume occurs when a market finishes a day of trading at a level lower than its previous close, meaning that the trading volume for the day was more bearish than bullish.
- If today’s close is equal to yesterday’s close then: OBV = Yesterday’s OBV.
“Beans on balance” (below) shows the January 2014 soybean futures contract with both volume and the OBV indicator. You can see how the OBV indicator is affected by both the volume data as well as price changes.