The indicator works by predicting reversals or confirming trends. Description of how the indicator works
Joseph Granville wrote out the results of daily trading in the form of an endless series of positive numbers for the candle that closed above the opening, and negative numbers if the price at the end of the day was below the level of opening session. Further the author constantly summarized the obtained results: OBV= ∑ k*Volume, where the coefficient k determined the +/- sign by the position of the closing price of the candle. As we can see from the formula, the indicator curve can take positive and negative values at long trends, indicating the global market trend at the current moment. The OBV has no period, applying a "through" summation, which shows the cumulative value of the volume.
The figure above demonstrates the high level of correlation between the indicator trends and the quotes of the asset, this is one more useful factor that simplifies the analysis. The regular histogram of volumes can increase when the price falls or rises, making it difficult to find divergence signals when the trend is not confirmed by the activity of the traders. The OBV's correlation to the chart instantly displays a picture of the market, visually confirming or denying both types of price trend.
This quality becomes especially important in the most complex parts of flat trading, where uncertainty brings the trader the greatest amount of losses. The volume analysis allows to determine the hidden movement and correctly predict the trend.
The OBV formula does not take into account volumes of day trading on cross candlesticks whose price closes at the opening level of the session. How to use the indicator in trading
Divergence OBV is one of the most widely used signals by analysts. The classical variant of using the divergence of the price and indicator trends is described on the thematic resources and in the encyclopedias. It means that the increasing or decreasing trend of the quotes, which is not confirmed by maximums or minimums of On Balance Volume, is interpreted as the coming price correction. Such a strategy works vice versa in the Forex market. The OBV divergences confirm the current trend with the first extremums of divergences. In the picture you can see how the market falls when the OBV demand remains high. The high volumes should show that bidders are ready to keep buying, but the downtrend soon ends with a big drop.
Next we see volumes continue to fall, but the currency pair has reversed and continues to make new highs. Despite the "absence" of buyers according to the OBV data, the EURUSD quotes show strong momentum. History repeats itself at a new market top: high On Balance Volume readings on a falling trend lead to a sharp dip. This proves that all the OBV divergences confirm a high probability of the current price trend. On Balance Volume shows the classic "crowd fault". If the majority of traders play the role of bulls, the big players are ready to crash the market in order to gain on stop losses. The classic strategy of using the indicator is to trade on trend confirmation. As noted above, the OBV formula "binds" the curve to the rate of the currency pair. Traders make transactions: BUY on breakdown of the maximum of the indicator, if prices continue to grow; SELL on breakdown of the minimum, if prices continue to fall.
The counter-trend signals on the trading indicator are determined by the support and resistance lines, which are similar to the graphical analysis of the price: BUY deal is opened after the double bottom appears, if the OBV was declining before; SELL deal is opened after the second peak, which was formed at the end of a growing trend.
The strategy's money management is based on stop-losses placed behind the daily candlestick minimums or maximums, not exceeding 100 pips, but not less than 50 pips for the major currency pairs. Profit taking takes place: for a short trade when the correction exceeds the penultimate maximum of descending trend OBV; for a long trade when the previous minimum of rising trend indicator is broken on the correction. Description of settings
The On Balance Volume indicator is located in the "Volumes" section, "Indicators" option, "Insert" menu of the Metatrader 4 and 5 trading platform.
Indicator settings window practically does not contain parameters able to influence calculations, except for changing of reference points in the form of choosing prices: closing, opening, maximum or minimum. In the classic version, Joe Granville recalculated the indicator at each close of a daily candle. The "Levels" tab plays a technical role, the trader can mark the historical highs and lows of On Balance Volume readings to consider when they break a level or trend correction.
Conclusion
The cumulative system of OBV volumes with multiplication by positive and negative coefficients greatly "simplifies" the fluctuations of quotations, while maintaining the trend direction that coincides with the market. The indicator is recommended for beginners who are new to VSA theory or have difficulties in determining the direction of the current asset movement. Another plus of OBV for beginners the indicator has virtually no settings, so it does not require searching and selecting parameters. When applying the curve in technical analysis, it should be taken into account that it is difficult to evaluate the market with one instrument. Currency speculator should apply On Balance Volume in trading systems together with graphical patterns or other indicators.