On Balance Volume (OBV): Ultimate Guide of Using OBV Indicator in Forex Trading | LiteFinance (2024)

This article is a step-by-step guide to the On Balance Volume leading indicator. You will learn what is OBV, how to use it, how to customize the OBV settings, and interpret the signals to buy and sell.

This indicator is a technical tool used to anticipate price moves based on trading volumes and known market data. It confirms the ongoing trends and spots the pivot points, and support/resistance levels. The on-balance volume is quite simple and user-friendly.

This indicator was originally designed for work in the stock market, later, it has been successfully used by Forex traders to measure buying and selling volumes of various assets. The creator of this indicator believed that the main driving force in the financial markets is volume. Compared to other momentum indicators, the OBV is efficient in trading almost all Forex instruments.

Traders can use this tool to measure any asset’s trading volume, by collecting multiple market data and providing a detailed analysis of stock charts, futures, and cryptocurrencies. The OBV is also well-combined with other technical tools. I will cover all the aspects of trading with the OBV in this review.

What is On Balance Volume (OBV) Indicator

The On Balance Volume is a leading indicator that measures the volume changes to make daily volume price predictions and recognize incorrect prevailing trends. It is based on the theory that a significant price movement always follows a sharp change in the trading volume. For example, when large traders invest in securities, the trade volume, and the stock price increase. The asset price will also rise sometime later.

You can read detailed instructions on adding indicators to the MT4 charts in the articleBollinger Bands Indicator in Forex Explained.

The On Balance Volume is displayed at the bottom of the chart. The OBV line goes up when today’s closing price grows and goes down when yesterday’s closing price is higher than the current one. A sharp move of the indicator suggests big traders are stepping into the market by placing a significant amount of smart money. Conversely, a smooth movement indicates that other traders are entering the market.

I offer a brief description of the On Balance Volume so that you can understand how the OBV works.

OBV:

• The OBV is a momentum indicator that measures positive and negative volume changes to predict price movements.
• The OBV shows the sentiment of big traders and the crowd to predict a bullish or bearish momentum.
• The OBV calculation formula is as follows: if the current closing price is higher than the last closing price, the current OBV is added to the previous value and the OBV has the role of a cumulative indicator. When the previous closing price is lower than the current closing price, the prior value substracts volume of the current value.
• The OBV doesn’t consider the price movement intensity.

The On-Balance Volume is the best in trading markets. In this case, it spots the pivot points or the trend continuation signals and indicates the incorrect prevailing trends. However, it doesn't perform well in the short-term timeframes since there is not enough market data to analyze. The reason is the natural volatility that may affect the indicator signals.

OBV Indicator History

The history of the Balanced Volume indicator goes back to the 1940s. In 1946, stock analysts Woods and Vignola developed a technique, called initially "continuous volume", that became the On Balance Volume prototype.

Later on, the On-Balance Volume indicator was developed by a prominent financial analyst, Joseph E. Granville. Granville believed the trade volume to be the main driver of the financial markets. He popularized the OBV technique in his book New Key to Stock Market Profits. Granville compared the trade volume to the steam that is driving the market engine.

Later on, the OBV tool was more and more widely used. The Forex OBV indicator appeared with the popularization of currency trading. It has become so popular among forex analysts that it is now included in the standard list of technical analysis tools.

How does On Balance Volume Indicator Work

The indicator looks like the simplest graph with a signal line where the trading volume is depicted.

It does not show overbought and oversold levels like many oscillators and its absolute value does not matter here.

What does On-Balance Volume indicator tell you?

The OBV indicator sends the following signals:

• Trend confirmation. If there is positive volume pressure, the curved line goes up following the price rise. Otherwise, if there is a negative volume pressure then the line goes down following the price fall and the ongoing trend is likely to continue.
• Trend reversal (divergence). A buy signal, or bullish reversal, appears when the indicators line goes up (positive divergence) amid the downtrend of the price chart. A sell signal appears when the OBV line goes down (negative divergence) amid the uptrend in the chart.
• Level breakout. This signal works in a similar way when the price chart breaks out key levels. The breakout of the OBV key level is often followed by a sharp price momentum in the direction corresponding to the breakout.
• A sharp surge in volumes. The OBV trading tool shows the positive and negative volume of an asset like a stock price. If you see a sharp rise in the indicator line, it signals that big traders are entering the market. A strong on balance volume momentum is a trend reversal signal if it goes against the trend. It confirms the trend continuation when the indicator and the trading volume on the chart are going in the same direction.
• Crossing the Moving Average. If the on balance volume line breaks through the MA upside, it is a buy signal. When the OBV breaks through the MA downside, it is a sell signal.

Besides, all the above signals do not contradict each other, they often appear all at once, which could serve as additional confirmation.

The above chart is an example of how the OBV signals work together. The purple line marks a common bearish divergence. You see that OBV doesn’t confirm the uptrend indicated in the chart and a negative volume is spotted.

At the reversal point, there is a strong indicator momentum where the volume begins to fall. I marked it with the red arrow. This signal means strong selling pressure, which confirms that the uptrend should soon turn to a significant bearish outcome.

Amid this sharp price movement, the chart breaks out the red line in the OBV window. So, in this trading range, there is another bearish signal. Along with the entire down move, starting from the very beginning of the price fall, the indicator is following the price chart, confirming the bear trend continuation. I marked it with the blue arrow.

So, there is almost an entire range of signals on how the asset’s trading volume goes. Each next signal confirms the prior one.

How to install, run, and custom the OBV indicator?

You don't have to look for the MT4 OBV tool to download from the Internet. The On-Balance Volume indicator is among the standard technical tools to measure the total volume and is available on most trading platforms. So, the OBV must already be in your trading terminal.

You can find the On Balance Volume in the Indicators/Volume folders and add the tool by double-clicking on it.

Next, you will see the settings window. The Parameters section is elementary. You can set the chart, to which the indicator formula is applied(Opening price, Closing price, and so on), set the line color, and add highs and lows.

Default settings will suit, so you do not have to change anything. To confirm the settings, press the OK button at the bottom of the chart and you are ready to measure the trading volume of any asset like currency pairs, a stock price, etc.

OBV Indicator Calculation & Formula

I shall briefly describe how the OBV indicator formula is calculated. The on balance volume formula is as follows.

If the current closing price is higher than the previous closing price:

OBV = Previous OBV + current volume

If the current closing price is lower than the previous closing price:

OBV = Previous OBV - current volume

If the current closing price is equal to the previous closing price:

Current OBV = Previous OBV

As an example, let us assume that in the daily chart, yesterday’s stock price volume was 4064. The price continues growing today, and the volume is 203 points.

Therefore, the total OBV value by the end of the day will be:

OBV = 4064 + 203 = 4267, raising the stock market profits.

It is not convenient to calculate On Balance Volume manually. You’d better employ the MT4 tools. To make the OBV formula as clear as possible, I prepared a calculation model in Excel.

You can download the Balance Volume(OBV) Indicator Excel Sheet here.

If you have problems with the OBV excel sheet, refer to the step-by-step guide in the Bollinger Bands Excel section in the article Bollinger Bands Indicator in Forex Explained.

It is very easy to use the OBV Excel sheet.

You enter the values in the corresponding pink columns over the needed period – the closing price and the trade volume.

The values written in the pink columns are just an example of how the volume begins and the stock price is changing. You should delete them when you work with the excel sheet. If you do not know today’s volume level, you can find it out using a common tool Volume. You enter as values for each bar the closing prices and the current ones separately.

The table contains a formula for 25 bars. If you need to carry out the analysis over a longer period, just stretch the table below.

On the right side of the table, there are the price and the on-balance volume charts. They will be recalculated automatically after you enter new values into the table. With the help of these charts, you will be able to carry out the same analysis as in the trading terminal.

On Balance Volume Indicator Interpretation: Reading the Charts

On balance volume is a momentum indicator. It considers only the movements up or down.

An essential analysis element is a comparison of the On Balance Volume line movements and the price changes for a chosen trading period’s volume. I presented examples of such analysis above.

OBV Divergences

Divergences lagging indicators are quite common signals. Divergence occurs when the indicator and the daily volume on the chart go in opposite directions. There can be bullish and bearish divergence depending if there is a negative or a positive volume pressure.

I covered the divergence signals in detail in the article Divergence and Convergence in Forex. The OBV divergence works in the same way as with other technical tools for a period’s volume.

Let's study a few examples of the OBV divergence indicator:

Purple lines in the above chart mark divergence. Note that the chart indicates a downtrend while the on balance volume line starts rising gradually. Finally, the trend reverses, and instead of a bearish outcome, a bullish trend starts (red line).

A bear divergence occurs in the opposite situation. The price chart rises, and the OBV line goes down presenting a negative volume pressure. An alternative is the sideways movement of the OBV in a bull trend. In both cases, the signal means a soon price reversal, and a bearish trend starts, confirming the rise of the selling pressure.

The chart schematically displays a bearish divergence (purple lines). The up days show a daily volume increase and the line goes up while the on-balance volumes are gradually declining. Later, the trend turns down (red line).

There is a special technical tool designed to spot divergences quickly comparing the yesterday’s closing price with the current. It is TrueT OBV Divergence Indicator.

The TrueT OBV Divergence analyzes the last 300 visible bars and paints diverging lines in the On Balance Volume window. A great benefit of this tool is the alert signaling divergence and many additional settings compared to the classical version.

OBV Trend Confirmation

In trading with the trend, it is important to understand if the ongoing trend is exhausting or if it will continue. Here, we can use the OBV trend confirmation signal to measure positive or negative volume outcomes.

When the bullish trend is developing and the up days are coming, the OBV hits higher highs. The same is in the opposite situation when the volume follows the down days. Thus, the bear trend is confirmed when the previous OBV lows are lower than the current ones.

The green line in the above chart marks a bullish trend where the closing price is higher than the previous one. The OBV line also demonstrates an uptrend. Therefore, while we measure positive today’s volume the line is getting up and the uptrend strength is confirmed.

OBV Breakout

A typical trading signal is the breakout of the support or resistance line. It signals the current trend is strong, and it should continue.

There are also false breakouts when the price breaks out the support or resistance line for a short time and then goes back leading to a positive or negative volume flow.

The technical indicator OBV helps one spot such breakouts. Traders use the previous OBV breakouts to filter false signals and understand the positive and negative volume outcomes.

The principle of spotting false breakouts is based on trend confirmation techniques. A strong trend is always accompanied by the OBV line moving in the same direction. When the trend is false, the OBV line is going in the opposite direction.

To check the strength of the breakout of the support and resistance levels, you need to draw a similar line on the On Balance Volume chart. If the OBV line also breaks through the levels, the breakout is true. If it doesn’t, there is a false breakout. You should also remember that the OBV signals usually happen a few bars before the price movement.

The green lines in the chart mark the support levels to the price and the open blue represents the indicator. The red arrow marks the breakout point where the selling pressure is considered low. The on-balance volume, however, is going down indicating a negative volume flow.

It means the smart money (large traders) do not take part in the price movement. So, the trend is unlikely to continue, and the breakout is false.

How to Trade Forex with On Balance Volume Indicator

So, we have studied how the OBV index forex works, how to read OBV signals, and how to interpret the on balance volume chart. Now, we shall see how to trade the OBV in Forex and boost our stock market profits. Traders use this indicator both to predict trend reversals and to confirm the trend continuation.

TheBTCUSD chart above displays one of the most common lagging indicators, the bearish divergence. It signals the trend reversal. So, we expect the down days to come and we open a short position. After that a confirming signal follows.

We enter a trade when the first relatively long black candlestick finishes. It is clear from the chart that the trendline is not broken out, but the indicator already goes down at the bar’s closing price and a strong negative volume follows.

So, the indicator delivers the sell signal, and we can enter a short trade (blue horizontal line).

A stop loss is set a little higher than the most recent local high (red line).

A take profit is approximately equal to the stop loss (green line).

Soon, the bitcoin price drops sharply and crosses the take profit level, and the trade is exited automatically before the trade goes further to the down days and investor lose money rapidly.

There is also an alternative trading scenario. When the bitcoin price goes down to the first target at the distance of the stop loss, we move the stop loss to the breakeven.

To take the profit, we expect the reversal signal of the OBV indicator, bitcoin. The signal appears when the resistance level is broken out (red section of the chart) and the classical bullish divergence (green sections). The bitcoin OBV indicator signal is confirmed when there appears a long white candlestick (marked with the red arrow). When the candlestick closes, we can exit the short trade and enter a long.

Let us explore how to trade trend reversals on the example of IBM shares, where we can monitor how the stock price is fluctuating, due to positive and negative volume reversals.

The chart shows a clear divergence between the price chart. This bearish divergence signals a soon trend reversal. The confining signal to enter a short is when the IBM price goes below the trendline, and the indicator breaks out the support level. Note, the On Balance Volume serves as a filter and confirms the trendline breakout with a slight delay.

When the signal is confirmed, we look at the difference between the opening and closing prices. The next bar closes with a down gap, which is another bear signal. We enter a short by market.

A stop loss is set according to the common principle, a little higher than the local high (red line in the chart). We shall take the profit manually when the opposite reversal signal appears. Thus we have a higher risk of a loss, but the potential profit is also bigger this way.

As you see from the above chart, the IBM price goes down after we enter a short. There is forming a bear wedge that signals a reversal. Such a pattern usually ends with a bear divergence. The price is going as expected.

I should note that the trendline breakout in the On Balance Volume window occurs a little earlier than in the chart. I take the profit once the breakout bar closes. I mark this bar with an arrow and the exit point with a green line.

Intraday Trading with OBV

Intraday trading is similar in terms of spotting and reading the OBV signals. The values of the indicator do not depend on the period, unlike other, more popular oscillators. The difference is in the timeframes. Intraday on balance volume trading strategy suggests trading in the previous OBV charts from M5 to M30.

I take the USDJPY five-minute chart as an example.

There is a very unusual divergence when the indicator breaks through the highs, but the price chart doesn’t. This divergence is not typical for a bull trend. I can explain it with the features of the on balance volume. Despite the high trading volume, the price doesn’t break through the high, which means selling pressure from large traders.

Such a type of divergence is quite common in the minutes’ charts, where the trade volume in a short period is important.

All the rest with OBV intraday trading is the same as in the examples I described above.

We are waiting for a confirmation signal from the price chart and on-balance volume. The uptrend should change relative to the previous bars, and the trend line will be broken. We enter a trade at the close of the signal candlestick.

Due to the high volatility within the day and the abundance of false signals, we set a take profit level at a fixed distance twice as long as that of the stop loss. The stop loss is set at the local high.

In the case of the bullish reversal in intraday trading OBV, the strategy is the same. The only difference is that the stop loss is set at the local low.

The above chart displays a good example. There is an untypical divergence. It looks like an expanding bullish formation. However, the price breaks through the local lows in the expanding formation, and the situation is the opposite in our example.

I should note that the OBV signals do not always work out; it is clear in minute timeframes. The red circle marks such a false signal, where the On Balance Volume line doesn’t react to the price rise. But the uptrend continues.

Trading with On Balance Volume OBV and Moving Average indicators

You can combine the On Balance Volume with other technical analysis momentum indicators to filter and confirm signals to buy or sell. This way, you can increase the performance of your OBV strategy and have more winning trades. You can use the OBV and Stochastic or trend indicators. One of the trend indicators, the Bollinger Bands indicator, is covered in thisarticle.

Now, I would like to give an example of a successful OBV trading strategy. It is the OBV indicator with moving average in the MT4 platform. You know that the MA is a lagging indicator. To reduce the time lag, I recommend using the EMA and the OBV indicators together.

To trade the MA and OBV forex strategy, you need to add two exponential moving averages with periods 34 and 12.

Entry conditions:

• The OBV diverges from the price chart. Or the price and the indicator line stop close to the support or resistance level.
• To measure buying volume and enter a buy trade, the EMA 12 should break through the EMA 34 upside. To enter a sell trade, the fast EMA breaks the slow EMA downside.
• The stop loss is set close to the next local high/low.
• As the exponential moving average is an additional signal filter, I recommend setting the take profit at a distance equal to the stop loss. You can also exit the trade manually when the fast EMA breaks through the slow EMA in the opposite direction.

Let's see how this strategy works on the example of the EURUSD chart:

The purple lines in the chart connect the highs of the candlesticks and the OBV peaks. There is a divergence, so, we can anticipate a trend reversal.

The initial interpretation of the signal confirms the trend line breakout in the on balance volume window. As expected, the fast EMA 12 breaks through the slow EMA 34 downside a little later (red circle). When there opens the bar immediately after the crossing, we enter the trade (blue horizontal line). A stop-loss and a take-profit are set according to the trading strategy rules (green line).

The sideways trend is indicative here, I marked it with the red oval. You know that MAs often send false signals in trading flat, and this results in a loss. OBV helps us avoid a loss.

It is clear from the above chart, the indicator does not rise during a flat and does not cross the resistance level (the blue line). This allows us to hold the position and the market and not to close it too early.

As a result, the profit is taken at the TP level (green line).

Advantages & Limitations of OBV Indicator

The OBV has some advantages and flaws we should consider when trading with the on-balance volume indicator.

Advantages:

• The calculation formula is very simple, and it is easy to use.
• The OBV delivers diverse signals of trend continuation or trend reversal. They are the OBV line direction, divergence with the price chart, breakout of the important levels, or the trendline.
• The time lag is very short, if any. In most cases, the OBV signals are early.
• The signals in medium-term timeframes are entirely accurate showing a positive or negative volume.
• It doesn’t repaint.

OBV limitations:

• A surge in trading volume can result in an unreasonably sharp jump of the indicator and give a false signal on the closing price.
• It doesn’t suit low-volatility instruments with low trade volumes.
• In short-term timeframes, the previous OBV signals can be mixed by the natural volatility or the price noise. In this case, the On Balance Volume can send false signals.
• You need a long trading history to carry out the market analysis effectively and not only yesterday’s and today’s closing price.

Recommendations on trading with the OBV

Considering the OBV trading tool description and the above information, I want to sum up and give some tips on using the OBV to measure the daily volume and monitor the price trend:

• Take advantage of the instrument, filter false reversal signals, and check the trend strength.
• Сonsider all divergences in the OBV index and the data on the chart, not just common divergences in order to understand future price movements. Also, use breakouts of the key levels and other chart patterns in the Balance Volume window.
• OBV oscillator is a good complement to both trend indicators of technical analysis and oscillators. If your strategy doesn't take volume readings into account, this tool can be a great addition to recognizing the price trend.
• Avoid using indicator signals on low-liquid assets and short timeframes. Do not use it on timeframes less than M15, since it doesn’t give precise predictions for future price movements.
• On Balance Volume is efficient for different investment assets: currency pairs, cryptocurrency, and stocks. But it is ineffective in short timeframes due to price noise. Therefore, professionals prefer to trade the OBV on charts of M15 and longer to measure the daily volume and understand how the price trend will move.
• OBV signals cannot be the basis of a trading strategy and must be confirmed by signals from other technical analysis tools.

The On Balance Volume is not that popular among technical analysts and traders. The signals are not clear at first sight; you need to be able to spot signals and interpret them correctly. So, do not waste time and open a demo account in a couple of clicks. Apply the information from the article to practice to develop your skills and start trading like a professional.

P.S. Did you like my article? Share it in social networks: it will be the best "thank you" :)

Ask me questions and comment below. I'll be glad to answer your questions and give necessary explanations.

Useful links:

• I recommend trying to trade with a reliable broker here. The system allows you to trade by yourself or copy successful traders from all across the globe.
• Use my promo code BLOG for getting deposit bonus 50% on LiteFinance platform. Just enter this code in the appropriate field while depositing your trading account.
• Telegram chat for traders: https://t.me/litefinancebrokerchat. We are sharing the signals and trading experience.
• Telegram channel with high-quality analytics, Forex reviews, training articles, and other useful things for traders https://t.me/litefinance

Price chart of EURUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.