Volume Trading Strategy: On-Balance Volume Indicator and More

April 20, 2021 08:30 UTC
Reading time: 23 minutes

Have you heard of volume in trading? Perhaps you have, but do you know what it is? Do you know how to use it to your advantage in trading? If not, you're in the right place. It's time to take your trading up a notch by learning this key aspect of the markets. This article provides you with an in-depth understanding of volume, the On-Balance Volume Indicator, bullish and bearish divergences, different volume trading strategies and much more!

Let's begin!

 

What is Volume?

You may have heard of volume in trading and you may even know what it is. For some of you, you may see it as another of the many complicated aspects of trading that seem overwhelming to consider altogether.

Volume is a measurement indicating the number of units of a security that has been traded over a certain period of time. For example, in shares, it's the number of shares of a particular stock that was traded. With ETFs, it's the number of contracts that changed hands over that specified time.

A security may be traded each day the markets are open, but the number of units of that security that are traded each day fluctuates - or, the traded volume of that security fluctuates.

So, how do you learn volume in trading? Volume and the trading strategies that use it are made simple with volume indicators, like the On Balance Volume indicator. You may have asked, "How do you read price action and volume?". You can find the daily trading volume by yourself — all daily transactions are public — by determining the total number of shares that were traded.

However, price charts and tools like the On Balance Volume indicator make it much easier. They calculate it for you, making your volume trading strategy much less complicated. This frees up more space in your mind to consider other factors affecting your trading decisions.

Looking at shifts in volume, over time, can help a trader understand the strength behind bullish and bearish trends in certain stocks and entire markets. This is also true for options traders, because volume indicates the current interest in an option. Volume plays a key role in technical analysis and is a primary component of some important technical indicators.

What is Good Trading Volume?

In short, what can be considered a good amount of trading volume is different for different securities. With stocks, for example, a good general rule of thumb is that thinly traded stocks are highly speculative and unpredictable. This makes them dangerous.

If there are few shares of a stock, one investor could come in and purchase a large portion of the available shares, causing the price to skyrocket. On the other hand, if an investor chooses to sell, the price could quickly plummet.

In general, low-volume, thin stocks are risky investments. It's better to stick with stocks that have a minimum dollar volume in the range of $20 to $25 million. Actually, the higher the better.

But what about volume in Forex? In trading Forex, volume is primarily used to confirm trends and reversals. Volume can confirm the strength of a trend, the weakness of a trend and help you determine if a breakout is imminent.

For example, if the market is in a downtrend, and the volume begins increasing, this indicates that the number of buyers is increasing and the bearish trend may be slowing or a reversal is imminent. I discuss this in more detail in later sections of this article.

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What Is the On-Balance Volume Indicator?

What is the OBV meaning? 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. This is the OBV meaning. 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

I discuss each of these in more detail in the following sections.

How to install the On-Balance Volume Indicator in MetaTrader 4

The MetaTrader 4 trading platform makes it very easy to quickly install the volume indicator MT4 into your chart on the platform. To install the volume indicator MT4 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 volume indicator MT4 is primarily used when trading stocks, indices and Forex, but due to the sheer volatility of cryptocurrencies, these are also traded with the help of the volume indicator MT4.

Trend Line Strategy with the OBV

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 sustainably 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. This information can help us identify trends (trend lines) and trend reversals to find trading opportunities.

All of these details on the on-balance volume indicator strategy help traders develop a deeper understanding of the OBV meaning.

It's time we look at how to implement a moving average into our volume trading strategy with the on balance volume indicator in MetaTrader 4.

Applying a moving average in MetaTrader 4

To apply a 20-period exponential moving average to pair with your volume indicator MT4, 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 volume indicator MT4 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 volume indicator MT4 strategy, especially when paired with the Admiral Pivot Indicator.

Depicted: MetaTrader 4 Supreme Edition - EUR/JPY M15 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

On Balance Volume Indicator Divergence - Detecting Trend Reversals

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:

Bullish Divergence

Depicted: MetaTrader 4 Supreme Edition - AUD/USD M15 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Bearish Divergence

Depicted: MetaTrader 4 Supreme Edition - EUR/JPY M15 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

Forex OBV Trend Strategy

This trend trading Forex strategy suggests using the following indicators:

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 an 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 to 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:

Depicted: MetaTrader 4 Supreme Edition - GBP/JPY H1 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

A short entry is made when the upper BB is broken, and when the price returns to 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.

Depicted: MetaTrader 4 Supreme Edition - USD/JPY H1 Chart - Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication 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.

If you're ready to start trading, the Admiral Markets live account is the perfect place for you to do that! Trade CFDs on 80+ Forex currency pairs, choosing from a range of Forex majors, Forex minors, and exotic currency pairs, with access to the latest technical analysis and trading information.

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I'll now discuss some other volume trading strategies.

Percentage of Volume (POV) Trading Strategy

The Percentage of Volume (POV) trading strategy, also known as the Participation Rate, is a strategy that executes an order quantity based on a percentage of the trade volume of a specific stock over a specific time interval.

With this strategy, traders can limit the amount their order contributes to the overall average daily volume. This minimizes their impact. Traders set a percent value to control their participation between a chosen start and end time. The order quantity and the volume distribution throughout the day is determined via the volume percent you entered as a target, along with regularly updated volume forecasts.

When & Why Choose POV?

  1. When you are executing big orders within a set time
  2. When you are content with the current and expected market price (POV executes near the market price)
  3. To completely execute an order with no limit on the price band - POV executes near the market-determined price
  4. To execute at a near-market price, this strategy may utilize a predictive algorithm to determine the quantity and price of the next order
  5. To minimize your impact on the market via executing large volume over time
  6. POV can execute at the market price to keep up with the stock turnover, so be sure you specify an exact price band

Parameters:

The actual parameters a trader uses depends on their broker. But, here are general parameters to help you get an idea of what's best for you:

Start Time: No orders are executed on the market, even if the logic produces a buy or sell signal before the Start Time.

End Time: Every open order is completed before this time, regardless of what impact it will have.

%Volume: This strategy automatically sets your participation rate to not exceed the percentage of the stocks total traded volume. For example, if a stock is trading 100,000 shares per minute while your %Volume is set at 10, this strategy will choose to trade 10,000 shares in a minute.

Price Brand: Your chosen price band for the average traded price. If the market shifts outside of this price limit, the order won't be fully executed.

Price Volume Imbalance

The Price Volume Imbalance strategy uses order flow, assessing the current bid and ask prices to predict the short term direction of a security's price. This means we look at the buy and sell orders currently visible on the market.

The orders we can see are limit orders - they will only be filled at a certain level. The buyers (bids) have placed limit orders to buy at a set price level or lower, while sellers (asks) have placed limit orders to be filled a certain level or higher.

However, we can't see the market orders - the orders that are filled at the first available price level. So we can see what orders have been filled, but we can't see what orders are about to enter and be executed. So, how can we use this order flow to predict the price direction?

There is 'footprint' software that exists for measuring the balance or imbalance between buy and sell orders that are being filled.

Footprint software will produce a footprint chart containing:

  • bids (buy orders) that were filled
  • asks (sell orders) that were filled

We then calculate the ratio of bids to asks and asks to bids. If there has been an exorbitantly larger number of fulfilled bids we may be able to predict that there there is an imbalance and it is on the downside.

There are a large number of sellers in the market, which will likely drive the price down in the short term. If the imbalance is on the upside and there is a significantly larger number of asks being filled, it may be safe to predict that the market will turn short term bullish.

In short, you can't determine which market orders are going to fall in. However, current buying and selling pressure can help inform your prediction.

When trying to use order flow in a price volume imbalance trading strategy to gain insight on which direction the price will move, this information is likely the closest you’ll get to understanding the forces moving the current market.

Volume Profile

Volume Profile is an advanced method of chart study that shows trading activity across specific trading and price levels. It is sometimes a key component of a volume trading strategy. This is also sometimes called volume by price. It displays the volume at specific price levels and ranges, contrary to many volume indicators, which display the volume based on a time frame.

The Volume Profile on a trading chart is represented by horizontal bars that correspond to each price. With volume and price data, traders can identify price ranges with high volume and determine resistance and support levels.

It's important to remember that Volume Profile updates each time a new order is executed. Additionally, it changes when the value area, point of control and the high and low volume nodes change multiple times in one session.

As the Volume Profile evolves throughout the trading session, more patterns will emerge, which traders take note of and they can identify new trading opportunities.

The Volume Profile is a reactive tool that uses volume behaviour and past price movements. With this information, skilled traders attempt to identify resistance and support levels. You can adapt this volume trading strategy to serve as a Volume Profile day trading strategy to identify trading opportunities throughout the trading day.

Many volume indicators and volume trading strategies can be adapted to suit different time frames. As such, they can be considered a volume trading strategy for intraday trading (longer time frames) or day trading (shorter time frames).

If you're eager to try these strategies in a trading environment, but are afraid of losing your capital, the perfect place to gain experience is in a free demo account with Admirals. You can trade with real market data and test your volume trading strategy in different scenarios to see if it's working before trading your money on the markets.

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Volume Weighted Average Price

The Volume Weighted Average Price (VWAP) is a popular benchmark derived from calculating the ratio of a stock's average share price to the total volume of shares that have been traded in a specific time period.

Essentially, it is a price measure for intraday charts that helps traders assess a stock's current price and determine if it is over-priced or under-priced, relative to the average price for that trading day. Traders often use this information to identify opportunities to enter or exit trades.

Why is it Significant? 

Because the volume weighted average price trading strategy considers both price and volume in its calculation, many analysts feel the VWAP is a more accurate representation of a stock's true average price.

It is based on historical data, so it is considered a lagging indicator. However, traders often use it to establish resistance and support levels for intraday trading. In this sense, it is a volume trading strategy for intraday trading.

Additionally, because institutional traders use VWAP as an execution activity benchmark, many traders consider the VWAP price as influential in the intraday price action.

Applying the VWAP 

The VWAP volume trading strategy is used primarily for trading on short term timeframes. A volume trading strategy for intraday trading using the VWAP may be as simple as purchasing the price that closes above the VWAP. This would serve as an entry. The exit would be at a predetermined level above it. However, trading strategies often entail a bit more complexity than this.

The reason for this is this widespread belief among both common and professional traders that a substantial number of institutional traders use this VWAP as a benchmark. Therefore, they believe that it's imperative to factor this dynamic into their trading strategy.

The result is that a trader may use this VWAP to filter their trading activity. They may only enter long positions when the price remains below the VWAP and short positions when it's above the VWAP. This is because buyers that may beat the benchmark are likely to establish support when the security is trading below the VWAP, than above it. Such a filter will probably perform well on days when a security is trading in a relatively sideways range.

On the other hand, a trader may use the VWAP as a filter in the opposite manner. They may believe that they should enter long positions only when the price is above the VWAP and shorts when the price is below it.

Such a filter is founded on the belief that traders watching the benchmark aren't able to get their desired price are forced to push the stock deeper into its current trend for that day. Such a filter will perform well on days that have a defined trend for that day, either downward or upward. This is the basis of the volume weighted average price trading strategy.

Trade With MetaTrader Supreme Edition

Having the right platform and a trusted broker are as important as the indicators and strategies you use. Admirals is an award-winning broker that offers the ability to trade CFDs on the Forex, stock, ETF markets and much more.

This is all made possible with a state-of-the-art trading platform - MetaTrader. Admiral Markets offers MetaTrader 4 and MetaTrader 5 with an enhanced version of the platform known as MetaTrader Supreme Edition (MTSE).

With MetaTrader, professional traders can utilize tools like the On Balance Volume indicator and many others to boost their trading capabilities. You can also access the latest real-time market data, insights from professional trading experts, and a range of additional features such as the handy 'Mini Trader' feature - enabling traders to buy or sell within a small window, without having to access the trading platform every time they make a change.

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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.

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