How to Read the On-Balance Volume (OBV) Indicator

On-Balance Volume (OBV) is a technical analysis indicator that helps financial market participants understand market sentiment. It predicts potential price movements by analyzing volume flow. OBV offers insights into an asset’s buying and selling pressure, providing a clearer picture of volume dynamics than daily volume histograms.

What On-Balance Volume Is

On-Balance Volume (OBV) functions as a momentum indicator, linking an asset’s trading volume to its price changes. Significant changes in trading volume often precede actual price movements. OBV creates a continuous total, revealing whether an asset is under accumulation (being bought in large quantities) or distribution (being sold heavily). The indicator provides a running tally of buying and selling pressure, making the direction of the OBV line more important than its absolute value.

How On-Balance Volume is Calculated

The calculation of On-Balance Volume involves straightforward rules applied to daily price and volume data. If an asset’s closing price is higher than its previous day’s close, the current day’s volume is added to the previous OBV total. If the closing price is lower, the current day’s volume is subtracted. If the closing price remains unchanged, the OBV total also remains unchanged.

For example, consider an asset with a starting OBV of 0. If on Monday its price closes higher with 100,000 shares traded, the OBV becomes +100,000. If on Tuesday the price closes lower with 70,000 shares traded, the OBV adjusts to +30,000. If Wednesday’s price closes unchanged, the OBV stays at +30,000. This continuous adjustment forms the OBV line, typically displayed below the price chart.

Interpreting OBV Signals and Trends

The OBV line provides signals through its direction and interaction with price trends. When both the asset’s price and the OBV line move in the same direction, it confirms the strength of the prevailing trend. For instance, a rising OBV alongside an increasing price indicates strong buying pressure and validates an uptrend. Similarly, a falling OBV concurrent with a decreasing price confirms significant selling pressure, supporting a downtrend.

Breakouts in the OBV line can signal potential price movements. If OBV breaks above a resistance level or below a support level, it may foreshadow a corresponding price breakout or breakdown. A sudden, sharp movement or “spike” in the OBV line indicates significant buying or selling activity, often preceding substantial price changes, particularly around news events or earnings reports. Such spikes suggest that large institutional investors may be positioning themselves before the broader market reacts.

Recognizing OBV Divergences

Divergence between the OBV line and an asset’s price action signals potential trend reversals. This occurs when price and OBV move in opposite directions, suggesting a weakening of the current trend’s underlying volume support. Such discrepancies indicate that the existing price trend might be nearing its end.

A bullish divergence appears when the asset’s price makes a lower low, but the OBV line forms a higher low or remains flat. This indicates that despite the price decline, buying volume is increasing, suggesting sellers are losing momentum and a potential upward reversal is brewing. Conversely, a bearish divergence occurs when the price makes a higher high, but the OBV line forms a lower high. This situation points to weakening buying pressure, even as prices rise, and can signal a potential downward reversal. These divergences often provide early warnings of shifts in market dynamics, allowing market participants to anticipate future price changes.