Indicators are an important part of conducting technical analysis. There are leading and lagging indicators. Leading trading indicators produce signals before reversals begin or new trends start forming. Lagging indicators are known as trend following indicators and they produce signals after the trend has already established. On Balance Volume (OBV) is a highly popular leading indicator. Let’s find out what OBV is exactly and how to use it in Forex trading.
On Balance Volume indicator overview
On Balance Volume is a technical momentum indicator that predicts upcoming price changes based on volume flow. It is based on the theory that trading volume has a great effect on the market. It was designed by Joseph Granville who based this indicator on the idea that if trading volume increases, but prices remain relatively constant, the market is going to shift in direction.
- Indicator type: leading indicator.
- Best timeframes to use: the best timeframe depends on your strategy, however, most traders and strategies use OBV indicators with 1h charts.
- Goes best with: Trendlines. Simple trendlines are very handy when it comes to trading using OBV. Trendlines show possible support and resistance levels while OBV predicts reversals. Both can help open trades and place stop loss and take profit orders.
- Placed on: Below the chart
Technical details of On Balance Volume indicator
On Balance Volume is a technical indicator that uses volume flow to analyze the market momentum. It calculates the total trading volume of the asset and if this volume is flowing in or out of the currency pair. When calculating the On Balance Volume, there are three versions calculated, based on the closing price of an asset. These are:
- If the closing price today is higher than yesterday – OBV = previous OBV + today’s volume.
- If the closing price today is lower than yesterday – OBV = previous OBV – today’s volume.
- If the closing price today is the same as yesterday – OBV = previous OBV
On Balance Volume is used to track the activities of institutional investors and retail traders, and then make decisions based on that. It can be used to spot institutional traders buying into an asset that retail investors are selling. This will keep the price relatively even, but soon volume will drive the price up. Here retail investors will start buying, and institutional investors will start to sell.
Calculating volume in Forex is a bit trickier than in other markets. Stock market is centralized and volume is calculated easily based on total transactions. Forex market is decentralized, meaning, trading currencies is occurring in many markets and nobody knows the total volume of trades. Forex volume is measured by measuring the rise in trading activity.
Practical application of On Balance Volume indicator
You can see the On Balance Volume (OBV) example on the Euro vs US Dollar chart. Traders use OBV divergence with price to predict price reversals. In this case, the pair is in a downtrend. You can open a long position when price action decreases and the On Balance Volume indicator shows increase at the same time. However, novice traders should be careful when trading reversals. For beginners, trend following is an easier method to make profits than trading the reversals.
FAQs on On Balance Volume in trading
Is On Balance Volume good indicator?
On Balance Volume gives clear signs of market movement making it a good indicator to use. However, the indicator should be used in a context. It’s not recommended for novice traders to trade reversals as it requires more skills and experience.
What does negative OBV mean?
Negative value on OBV simply means that today’s price is lower than the last closing price. Similarly, if today’s price is larger than the previous closing price, OBV value is positive.