- On-Balance Volume indicator is a technical indicator used for analysing the stock market.
- It is a momentum indicator which uses the volume flow to predict changes in the price.
- The indicator is based on the logic that if there is a significant increase in the volume level without much change in price, then the price will eventually rise or fall.
Formula for On-Balance Volume Indicator:
OBV = OBV(prev) + volume, (if close > close(prev))
OBV = OBV(prev) , (if close = close(prev))
OBV = OBV(prev) – volume, (if close < close(prev))
- OBV(prev) = previous On-Balance Volume,
- close(prev) = previous close price,
- Volume = latest trading volume amount
This is the 1 day chart of Infosys Ltd (NSE) around Dec, 2019 to Aug, 2020
- The main advantage of OBV is that it can be used to track the institutional investors.
- When the institutional investors buy the shares sold by the retail investors, there is a rise in the volume without much rise in the price level.
- Eventually, the rise in volume drives the price upward. Again at that point, large investors start buying whereas small investors begin to sell.
- Since the OBV is a cumulative value, a significant change in the value indicates a significant change in the volume traded, which takes place only when the institutional traders step into the market. Thus OBV is used to track the large investors.
- The main disadvantage of an OBV indicator is that it is a leading indicator.
- So, not much information can be extracted about what actually happened, which can lead to false results.
- Traders should use add few lagging indicators (moving averages) to balance the effect.