What is equilibrium volume (OBV)?
On-balance sheet volume (OBV) is a technical indicator of trading momentum that uses volume flow to predict changes in stock price. Joseph Granville first developed the OBV metric in the 1963 book Granville’s New Key to Stock Market Profits.
Granville believed that volume was the key force behind the markets and designed OBV to project when major movements would occur in the markets based on volume changes. In his book, he described the predictions generated by OBV as “a spring that coils tightly.” He believed that when volume increases dramatically without a significant change in the stock price, the price will eventually jump up or fall down.
- On-balance sheet volume (OBV) is a technical indicator of momentum, which uses volume changes to make price predictions.
- OBV shows the sentiment of the crowd that can predict a bullish or bearish outcome.
- Comparing the relative action between the price bars and the OBV generates more actionable signals than the green or red volume histograms commonly found at the bottom of price charts.
The formula for OBV is
OBV=OBVPrmev+⎩⎪⎨⎪⎧volume,0,–volume,yes close>closePrmevyes close=closePrmevyes close<closePrmevwhere:OBV=Current volume level in balanceOBVPrmev=Previous volume level in balancevolume=Amount of the last volume of operations
On-balance sheet volume provides a running total of an asset’s trading volume and indicates whether this volume enters or exits a given security or currency pair. The OBV is a cumulative total of volume (positive and negative). There are three rules implemented when calculating the OBV. They are:
1. If today’s closing price is higher than yesterday’s closing price, then: current OBV = previous OBV + today’s volume
2. If today’s closing price is lower than yesterday’s closing price, then: current OBV = previous OBV – today’s volume
3. If today’s closing price equals yesterday’s closing price, then: Current OBV = Previous OBV
What does the equilibrium volume tell you?
The theory behind OBV is based on the distinction between smart money, that is, institutional investors, and less sophisticated retail investors. As mutual funds and pension funds begin to buy an issue that retail investors are selling, the volume can increase even if the price remains relatively stable. Eventually, the volume drives the price higher. At that point, the largest investors start selling and the smallest investors start buying.
Despite being represented on a price chart and measured numerically, the actual individual quantitative value of OBV is not relevant. The indicator itself is cumulative, while the time interval remains fixed by a dedicated starting point, which means that the actual numerical value of OBV is arbitrarily dependent on the start date. Instead, traders and analysts look at the nature of OBV movements over time; the slope of the OBV line carries the full weight of the analysis.
Analysts look at the volume numbers on the OBV to track large institutional investors. They treat the divergences between volume and price as synonymous with the relationship between “smart money” and the disparate masses, hoping to show buying opportunities against the wrong prevailing trends. For example, institutional money can drive the price of an asset up and then be sold after other investors jump on the bandwagon.
Example of how to use equilibrium volume
Below is a list of the 10-day value of the closing price and the volume of a hypothetical stock:
- Day one: closing price equals $ 10, volume equals 25,200 shares
- Day two: closing price is $ 10.15, volume is 30,000 shares
- Day three: closing price equals $ 10.17, volume equals 25,600 shares
- Day four: closing price is $ 10.13, volume is 32,000 shares
- Day five: closing price is $ 10.11, volume is 23,000 shares
- Day six: closing price is $ 10.15, volume is 40,000 shares
- Day seven: closing price is $ 10.20, volume is 36,000 shares
- Day Eight: Closing Price is $ 10.20, Volume is 20,500 Shares
- Day nine: closing price equals $ 10.22, volume equals 23,000 shares
- Day 10: closing price equals $ 10.21, volume equals 27,500 shares
As you can see, days two, three, six, seven, and nine are active days, so these trading volumes are added to the OBV. Days four, five, and 10 are low days, so these trading volumes are subtracted from the OBV. On day eight, no changes are made to the OBV as the closing price did not change. Given the days, the OBV for each of the 10 days is:
- Day one OBV = 0
- Day two OBV = 0 + 30,000 = 30,000
- Day three OBV = 30,000 + 25,600 = 55,600
- Day four OBV = 55,600 – 32,000 = 23,600
- Day five OBV = 23,600 – 23,000 = 600
- Day six OBV = 600 + 40,000 = 40,600
- Day seven OBV = 40,600 + 36,000 = 76,600
- Day eight OBV = 76,600
- Day nine OBV = 76,600 + 23,000 = 99,600
- OBV of day 10 = 99,600 – 27,500 = 72,100
The difference between OBV and accumulation / distribution
On-balance sheet volume and the accumulation / distribution line are similar in that they are both momentum indicators that use volume to predict the movement of “smart money”. However, this is where the similarities end. In the case of on-balance volume, it is calculated by adding the volume on a bullish day and subtracting the volume on a bearish day.
The formula used to create the Accumulation / Distribution line (Acc / Dist) is quite different from the OBV shown above. The formula for Acc / Dist, without getting too complicated, is that it uses the current price position relative to your recent trading range and multiplies it by the volume for that period.
One limitation of OBV is that it is a leading indicator, which means that it can produce predictions, but there is little you can say about what actually happened in terms of the signals it produces. Because of this, it is prone to producing false signals. Therefore, it can be balanced by lagging indicators. Add a moving average line to the OBV to look for OBV line breakouts; You can confirm a breakout in price if the OBV indicator makes a simultaneous breakout.
Another note of caution when using the OBV is that a large increase in volume in a single day can upset the indicator for quite some time. For example, a surprise earnings announcement, being added to or removed from an index, or massive institutional block trades may cause the indicator to rise or fall, but the increase in volume may not be indicative of a trend.