Understandably, price is the most monitored indicator; however, price follows as a close second for many. Volume plays a defining roll in different technical analysis patterns and can be considered the fuel that drives advances and completes bottoms. It definitely provides a consensus opinion on the purest level.

On Balance Volume [OBV] is a widely known volume indicator created by Joseph Granville and discussed in his 1976 book, Granville's New Strategy of Daily Market Timing for Maximum Profit. OBV is a freely ranging oscillator that is used as a confirming-diverging tool. Mr. Granville strongly believes that volume is the determinant for security moves and considers this measure to be more important to monitor than price. He states, "" volume is a cause and price is an effect."

Using Harold Gartley's approach to volume as a supply-demand tool, Granville states that "volume makes the price trends" and as a result it leads price. Both volume and OBV are considered leading indicators. Although these statements seem like elementary technical analysis, reading Mr. Granville's work gives a stronger sense of urgency to understanding these concepts. He is truly committed to the study of volume for market analysis and OBV is a primary tool for him.

OBV is constructed by:

• Adding the period's total volume to the previous period's OBV value when there is a positive close,
• Subtracting the period's total volume to the previous period's OBV value when there is a negative close and
• Leaving the indicator unchanged when the security's close is unchanged.

Figure 1 provides a weekly line chart for QQQQ, the exchange-traded fund [ETF] that tracks the NASDAQ-100^®. The underlying index includes the top 100 Nasdaq stocks, minus the financials, which has translated into a relatively stronger performance in recent weeks versus the S&P 500^® Index and the Dow Jones Industrial Average^SM.

Figure 1: Weekly Line Chart for QQQQ with OBV
click here for larger view

In early August 2007 OBV's break of an upward trending support line (at the dashed vertical line) occurred one week prior to the price break of its upward trending support line. Although the final break of price along the same upward trending line occurred prior to the OBV break (at the solid vertical line), the horizontal lines drawn from a late July peak in price and OBV show that after the initial break, OBV failed to confirm the continued upward move in price.

Since OBV moves freely around a zero line, there are no overbought or oversold indications. The oscillator can continue moving upward or downward as conditions warrant. A relatively low reading in OBV does not mean the indicator will necessarily rebound.

While I regularly warn about the dangers of placing too much emphasis on a subjectively drawn support or resistance line, it doesn't mean I don't use them. Longer-term lines that include a greater number of successful tests are given greater validity, while shorter-term lines with less successful touches are appropriately given less. Know when you should be flexible with your tools and when you should not be flexible with them.

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Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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