On Balance Volume [OBV] is a volume-based indicator developed by Joseph Granville. One of the most notable things about Granville's approach is his focus on volume as the data piece for analysis. While volume may be excluded from a chart completely - as in point and figure charts - it's unlikely Granville chooses such a view for analysis. In his 1976 book, Granville's New Strategy of Daily Market Timing for Maximum Profit, he states, "" volume is a cause and price is an effect."
Quick Review
OBV is a freely moving oscillator that is used as a confirming/diverging tool. This means the indicator is not range-bound with pre-defined overbought or oversold regions. The data is reviewed on more of a relative basis. Both volume and OBV are considered leading indicators.
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.
One negative comment voiced by some technicians is the manner in which OBV assigns the current period's value. A 0.01 point rise results in the addition of the total period's volume, just as a 100.00 point rise does. Other indicators incorporate price data in their calculations, but as with so many other areas of trading, it's an individual preference.
Current Markets
In the last few weeks it's been a tale of two markets; technology strength seen in the NASDAQ-100® Index (NDX) and broader market weakness, particularly in the Financials, as seen in the S&P 500® Index (SPX) and the Dow Jones Industrial AverageSM (INDU). Analysts are left to decide whether NDX strength will lead the other two indices up or whether NDX will be pulled down by them.
This article uses QQQQ and SPY, the widely traded exchange-traded funds [ETFs] that track NDX and SPX, as proxies for the indices. Figure 1 provides a daily line chart for QQQQ which is the relatively stronger ETF of the two. Keep in mind that the daily chart includes more noise and may display weaker trends in place than longer term charts.
Figure 1: Daily Line Chart for QQQQ with OBV
click here for larger view
A trend line is drawn between two support or resistance points, and is confirmed with a third successful touch of the line. When using subjectively drawn lines such as the one shown in Figure 1, a bit more allowance for false breaks and moves that fall short of the line is required - particularly in the shorter-term. However, you still want to monitor price relative to the trend line.
When viewing the sharp rise in the Qs in early Nov, note OBV was failing to confirm the move. Most recently the breakout of QQQQ above the downward trending resistance line was confirmed by OBV, with a break that preceded price by a day. Since mid-January an upward trend appears in both price and OBV.
This represents a change in the behavior of the ETF; however, before getting too excited, note Price-OBV action for late summer 2008. Any reversal would need to start somewhere so it is certainly possible this recent bullishness will lead to more intermediate bullishness which in turn leads to something longer and stronger. It's also possible we have a series of bullish-bearish short-term indications before something develops on the weekly or monthly chart.
Figure 2: Daily Line Chart for SPY with OBV
While SPY has been the relatively weaker ETF of late, SPY's OBV may prove to be diverging from price on a daily basis since December. A test of the trend line drawn may come in the next day or so. It's also possible to draw other lines and monitor those.
So are the daily charts screaming for a buy or does weakness in SPY versus QQQQ suggest OBV is wrong? I believe the answer is no on both accounts " for me. First, I generally don't trade on this short a time frame. The main chart I use is the weekly chart, so I will look up one time frame (monthly) and down one time frame (daily). Before considering how a chart in an article impacts your possible trading decisions, be sure to remind yourself of your primary style and time frames.
As mentioned, when viewing daily charts expect more false moves or whipsaws and consider looking up a time frame to remind yourself of the bigger picture in place. Also be prepared to have some flexibility when it comes to subjectively drawn trend lines that are just materializing. You still need to trade with discipline, but keep in mind that the more successful touches for a support or resistance line, the more merit it has.
Figure 3: Weekly Line Chart for QQQQ with OBV (as of 2/18/09)
Moving to the QQQQ weekly chart you can see that the early February move above resistance was not confirmed by OBV and failed. This trend line was not validated and should possibly be re-drawn from the Oct peak to the Feb peak. Also keep in mind that we have two days remaining in the trading week so the latest data point for both price and volume is incomplete. If you want to monitor the price-OBV relationship over the weekend, note movement around valid trend lines and peak & trough values for both.
Figure 4 completes the series with a view of the weekly chart for SPY with OBV. Again we must wait for the trading week to end to complete the analysis. With price currently below the Nov low, it could be an interesting expiration Friday.
Figure 4: Weekly Line Chart for SPY with OBV (as of 2/18/09)
When viewing a new tool, be sure to recognize what portions of your regular analysis are subjective and possibly require more flexibility. View different time frames after identifying which is your preferred trading/investing time frame. Be sure to also note the performance of the tool during different types of markets, including bearish, bullish and volatile periods, as well as consolidations. Typically when you explore a new tool it's because the one you are using isn't providing a clear picture, so by noting the types of markets the indicator may excel can help you decide whether it's one that provides you with useful, new information.
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Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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