Good day everybody,
Welcome to CryptoGod-1's blog on all things crypto. Today we are going to continue the series on Technical Analysis and why it can be such an important asset for new or experienced traders. In this series I am covering some of the different Technical Analysis and Indicators which can be used to help determine market movement and sentiment when trading. For Part V the focus will be on On-Balance Volume (OBV).
On-Balance Volume (OBV)
The OBV is a momentum indicator which measures the positive and negative volume flow. It was developed by Joseph Granville in 1963 inside his book "Granville's New Key to Stock Market Profits." He was under the conclusion that volume was the driving force behind markets and designed the OBV to project when major moves in the markets would occur. It works on the theory that when volume increases or decreases dramatically, without any significant change in the assets price, it will lead to a large change in price either upwards or downwards at some point. Through measuring buying and selling pressure as a cumulative indicator the OBV can determine whether a specific asset is considered to be up-volume or down-volume.
Calculating an OBV
To calculate the OBV a user does so by adding the volume for a set period to a cumulative total when the asset's price closes up. If this is taken on the daily chart as an example, the closing price of the days candle is added to the day's volume when the price closes higher than the previous day. The day's volume is subtracted for the closing price of the day's candle when the price is lower than the previous day. If there is no change in price, the OBV remains the same.
If today's close is greater than yesterday's close then:
OBV = Yesterday’s OBV + Today’s Volume
If today’s close is less than yesterday’s close then:
OBV = Yesterday’s OBV – Today’s Volume
If today’s close is equal to yesterday’s close then:
OBV = Yesterday’s OBV
How to use OBV
To make use of OBV a user observes the rise and fall of volume shown on the chart. The actual value itself is not of importance, merely the direction it is going in. A few rules to observe when making use of the OBV are as follows:
- When the price of an asset and the OBV are making higher peaks and troughs then it is taken as a sign that an upward trend is likely to continue.
- When both the price of an asset and the OBV are recording lower peaks and troughs, then a downward trend is likely to continue.
- When the price of an asset is in a trading range, if the OBV is rising it can mean that accumulation is taking place and a upward breakout could be about to happen.
- When the price of an asset is in a trading range and the OBV is falling, it generally means distribution is happening and a downward breakout can be imminent.
- If the price of an asset is making higher highs but the OBV is not doing the same it will generally signal that the upward trend is about to fail and a negative divergence is about to take place. This will usually result in the price of an asset falling.
- When the price of an asset is marking lower lows but the OBV is not, usually this will result in the end of the downward trend. It is known as positive divergence and often result in an increase in price.
Granville developed these theories on the basis that volume precedes price action, therefore if the OBV is rising it is because of strong buying pressure and if it is falling this is due to strong selling pressure, As the OBV takes into account both buying and selling volume it will only rise when the buying volume outdoes the selling volume, and vice versa when it is falling. Taking into account his theory of volume precedes price, rising OBV should result in higher prices while falling OBV should result in lower prices for an asset.
Due to the fact the value of OBV is unimportant users should instead focus on the characteristics of the OBV line for reference. It is important to define the trend of an asset, which can be achieved through the use of other TA such as an EMA. Then a user must determine if the trend shown in the OBV matches the trend of the chosen asset. Finally, a user must determine any support or resistance levels for the asset. From there a user can determine the trend of OBV, and any changes if it breaks through the support or resistance levels are signals of breakouts. Users must beware of any spike in volume which can at times throw off the indicator by causing a sharp movement that will require time for the OBV to readjust.
As noted above, positive and negative (also referred to as bullish and bearish) divergence signals can be used by traders to anticipate any upcoming trend reversals. These divergences are fully based on the Granville theory of volume before price and therefore traders should be alerted to any potential reversal in price from the divergences shown on the OBV compared to the candlestick chart.
Below is an example of an OBV and 1 hour candlestick chart from Binance for the Bitcoin asset. The EMA is shown in yellow to highlight to users the trend, which was in a range while leaning downwards through this period The OBV is shown as the blue line chart below the candlestick chart. Remember, the value of OBV is unimportant, just the direction of the blue line. I have added in price lines to the candlestick chart, as shown in pink, while I have also added in line in white to the OBV chart to highlight the difference in level.
At the first point on the candlestick and OBV charts, circled in orange, the Bitcoin price hit a low of 41,665. The OBV dipped to a point of 282,252, although that value is unimportant I showed it to highlight the divergence. As the chart progresses, the price of Bitcoin dipped lower to a price of 41,112. At the same time, the OBV hit a point of 159,659. A negative divergence or bullish divergence occurred, as the price of the asset hit a lower low but the OBV did not. As you look further across the chart you can see a small rise in the price of Bitcoin to around 43,500 before a crash happened with the price going as low as 33,925. For traders who entered a short after they saw the divergence they would have been successful through their understanding of OBV and how volume proceeds price action. This is just one example of the use of OBV alongside a candlestick chart, and the simple calculation and understanding of TA.
In financial terms, a trader who entered a short of 10x leverage around the 41,500 mark and exited around the 35000 mark would have seen a 156% return, while a 100x would have seen a 1566% return. Obviously users should take into account the fact that Bitcoin rose to around 43,500 and may have required a second or third 'buying in' to ensure liquidation was not hit, depending on the leverage used, but the returns have outweighed the fees in the long run. Holding off before placing your long or short could have meant a trader entered around the 42,500-43,500 mark and gotten even more return for their trade, or held on all the way to around the 34,000 mark for additional returns. Seeing the OBV rise again continuously after the price of Bitcoin hit 33,900 would have been another indication to exit the trade as the increase in volume should lead to an increase in price.
Limitations of OBV
A limitation of using the OBV is that it is a leading indicator, meaning that it can often produce repetition in its predictions. It cannot give much information on what has actually happened, instead it looks ahead and therefore often needs to be balanced with lagging indicators. Simple things like adding a moving average line to the OBV can show when the OBV line has completed a break out, and from there a user can confirm if the indicator is making a concurrent breakout instead of falling for a false signal. User's must also beware than when a large spike in volume happens in a single day it can throw off the indicator for a long period of time. Things such as massive institutional block trades can cause the indicator to spike or plummet, but these changes in volume may not be indicative of a trend.
Conclusion on using OBV for TA
As a trader, whether it be day trading or long term trading, using the OBV can be very beneficial in in spotting spike in volume which can be indicators towards future changes in price. It is measured in buying and selling pressure, and evident through positive and negative volume via the OBV line rising and falling. Users can make use of the OBV to confirm any underlying trend in the market and to look for divergences that may precede a price change. It is not a standalone indicator, meaning it is best used in conjunction with other indicators.
As stated whether you are experienced or new, Technical Analysis can always be a useful asset when trading. Just remember it is not guaranteed and nobody can predict the future, no matter how certain you believe the patterns to be. It is always just another tool of the trade to help make more informed decisions when trading. It can be easy to get caught into false signals with the OBV, either due to a recent high spike in trading via institutional traders, or a false signal for a breakout. It is important to use OBV along with other TA which are lagging indicators, such as Moving Averages, to get the correct signals for buying and selling. Always zoom out, if trading on a 15 minute chart check the 1 hour or 4 hour or even 1 day chart to give you a better idea of the overall position of the MACD and signal lines, and if a crossover of a larger trend is due to take place compared to a short term trend.
You can find the previous parts to the series here:
I hope this post was beneficial and of some use, and I plan on continuing the series with the next instalment focusing on the The Average Directional Index (ADX). Of course each technical analysis provides different beneficial information, so combining your most trusted and favourite ones can be the best strategy for finding entry and exit points when trading.
Have a great day.
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