An In-Depth Look At The On-Balance Volume Indicator
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This article provides professional traders with an in-depth understanding of the On-Balance Volume Indicator. It will define what the On-Balance Volume Indicator is, it will provide a trading strategy that traders can use with the indicator, it will explore bullish divergence and bearish divergence, and much more!
What Is The On-Balance Volume Indicator?
The On Balance Volume indicator (OBV in short) was developed by Joe Granville in the 1960s. Back in those days it was a revolutionary indicator, and today, many professional financial market traders use this leading indicator for analysis and trading. The indicator considers volume as well as whether the volume is pushing prices up or down. It is used in technical analysis to measure buying and selling pressure.
It is a cumulative indicator, meaning that on days when the price increases, volume is added to the cumulative OBV total. If the price decreases, that day's volume is subtracted from the OBV total. The On Balance Volume Indicator is regarded by the industry as one of the most popular momentum indicators, and is best used to detect new trade opportunities in the following ways:
- Trend line strategy
- Trend reversal – divergence
- Forex trend strategy
How to install the On-Balance Volume Indicator in MetaTrader 4
To install the indicator on the chart, open your MetaTrader 4 trading platform and follow the steps as shown in the GIF below.
Source: MetaTrader 4 Supreme Edition - GBP/JPY M30 Chart - How to install an indicator on a chart in MT4
The OBV is primarily traded on stock markets, as well as indices and Forex, but due to sheer volatility, cryptocurrencies (with Admiral Markets you can trade with cryptocurrency CFDs) can also be traded with the help of the MT4 OBV indicator.
OBV Trend and Trend Line Strategy
Primarily, a stock market indicator and, according to MQl5.com, the basic concept used by Granville to design his OBV indicator was that when a stock closes higher than its previous daily close, the total volume of the day is considered up-volume. Conversely, if a stock closes lower than the previous daily close, all of its day's volume is considered down-volume. The cumulative total of the positive and negative volume flows formed the OBV line.
Granville's studies indicated that changes in the direction of the On Balance Volume indicator forecasted potential reversals in price direction. For instance, if the traders started to heavily buy a market (i.e. Forex, commodity, stock, equity), an increased volume would force the OBV line to climb, which in turn, would drag the price higher.
If the volume stopped rising within a buying trend, it was indicative of buying pressure starting to diminish, and the probabilities that the bull trend was no longer sustainable increasing.
The same applies to the bearish trend. To provide further confirmation that a trend may be weakening, Granville recommended using a 20-period moving average in conjunction with the OBV. As a result, the OBV users could then observe such events much more easily, by noting any crossovers of the OBV line and its moving average.
If the OBV shows a divergence from price movement, a price reversal is imminent. For instance, if the price is rising, but the OBV starts to drop, a possible selling opportunity may exist. To apply a 20-period exponential moving average, drag the moving average to the OBV window and apply the following setting:
Source: MetaTrader 4: Setting the parameters for the Moving Average
The following example shows us how the price is following a new uptrend, and how the OBV is following the MA very closely. Every time the OBV goes below and then above the EMA 20, the price rejects from the trend line, making another bounce in the upward direction. This can be a basis for an OBV strategy, especially when paired with the Admiral Pivot Indicator.
Source: MetaTrader 4 Supreme Edition - EUR/JPY M15 Chart - Data Range: 11 September, 2017 - 13 September, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
OBV Trend Reversal – Divergence
As with most divergences, the OBV can also act before the price, indicating in which direction a price breakout could occur. Understanding OBV divergence is very important. When the price is making a lower low, but the OBV is making a higher low – we call it bullish divergence. If the OBV is making a lower high, but the price is making a higher high – we call it bearish divergence.
If the trend is up and the OBV is showing a bearish divergence, traders usually take a short position when the price breaks below its current trendline. A stop-loss is placed above the most recent swing, and higher in the price. Traders might opt to hold the trade for as long as the OBV confirms it, and when the price is trending lower towards the support.
If the trend is down and the OBV is showing a bullish divergence, traders usually take a long position when the price breaks above its current trendline. A stop-loss is placed below the most recent swing, and higher in the price. Traders might opt to hold the trade for as long as the OBV confirms it, and when the price is trending higher towards the resistance.
OBV divergence always works best when the price is at resistance (for short trades) or at support (for long trades). A good option is to use the Admiral Pivot indicator which is part of the award-winning MetaTrader Supreme Edition plugin for MetaTrader 4 and MetaTrader 5, as shown in the examples below:
Source: MetaTrader 4 Supreme Edition - AUD/USD M15 Chart - Data Range: 11 September, 2017 - 13 September, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
Source: MetaTrader 4 Supreme Edition - EUR/JPY M15 Chart - Data Range: Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
Forex OBV Trend Strategy
This trend trading Forex strategy suggests using the following indicators:
- Admiral Pivot set to D1
- Bollinger Bands® (50,2)
- OBV with EMA 20 applied
Which FX currency pairs could be used with this strategy?
It is recommended to trade with all Major pairs including GBP/JPY and EUR/JPY. The strategy is traded on a H1 timeframe. The Bollinger Bands® use the period of 50 to allow for higher price fluctuations. The price needs to break the upper or lower Bollinger bands®. A long entry is made when the lower BB is broken, and when the price returns back into the BB.
Then we just wait for the OBV to break the EMA20 from below, and then close above it. The target is the first, the second, or the third Admiral Pivot resistance line above the entry, whereas the stop is placed 5 pips below the last low. Take a look at the long trade example below:
Source: MetaTrader 4 Supreme Edition - GBP/JPY H1 Chart - Data Range: 5 September, 2017 - 13 September, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
A short entry is made when the upper BB is broken, and when the price returns back into the BB. Then we just wait for the OBV to break the EMA20 from above, and close below it. The target is the first, the second, or the third Admiral Pivot support line above the entry, whereas the stop is placed 5 pips above the last low. Take a look at the example of a short trade below. You can see how the price closely follows the Admiral Pivot.
Source: MetaTrader 4 Supreme Edition - USD/JPY H1 Chart - Data Range: 21 August, 2017 - 31 August, 2017 - Please Note: Past performance does not indicate future results, nor is it a reliable indicator of future performance.
Bear in mind that in Forex, the OBV needs to be used with other trading indicators to confirm signals, as we showed in the examples above. In trending markets, the on-balance volume trading strategy coupled with Admiral Pivot support/resistance levels should be a reliable trading approach. Furthermore, the On Balance Volume indicator provides another dimension of the market to help us confirm trends, momentum, and divergence.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.