How does trading volume influence price movements: understanding OBV

Modern trading requires a deep understanding not only of price fluctuations but also of the volumes accompanying them. The On-Balance Volume (OBV) indicator does exactly that — it analyzes the relationship between volume dynamics and asset price movement.

Basic Mechanism of OBV

Unlike simple volume analyzers, OBV operates on the principle of accumulation and is calculated by adding the volume on days when the closing price is higher than the previous session, and subtracting it on down days. When an asset closes higher than the previous session, the entire daily volume is considered a positive buy signal. Conversely, if it closes below the previous session’s price, the volume is interpreted as selling pressure.

This method of predicting price changes is universal among volume-based indicators, such as the Clinger oscillator and the Money Flow Index, but it works exclusively in actively traded markets.

Historical Origin and Philosophy of the Indicator

Joseph Granville, the developer of this methodology, proposed a revolutionary theory: volume is the primary force driving financial markets, and price fluctuations are merely a consequence of changes in trading activity. According to him, if the trading volume of an asset suddenly increases, it precedes a significant price jump — in both bullish and bearish directions.

Recognizing Reversals and Divergences

One of the most effective ways to identify potential breakouts is to analyze closing prices through the lens of OBV. However, it is important to consider that the indicator may lose reliability during sudden volume spikes, and traders should expect the completion of the calculation period during such times.

A key signal for predicting trend reversals is divergence. Bearish divergence occurs when OBV decreases or closes below the previous minimum, while a bullish divergence forms when OBV rises and closes at a higher price. These signals are based on the premise that volume forewarns of price changes, acting as a leading indicator.

Limitations and Practical Recommendations

However, no single metric can provide a complete picture of the market on its own. OBV is no exception. It should be used in conjunction with other technical analysis tools to increase the reliability of trading signals. A dependable forecast of bullish and bearish trends requires a comprehensive approach, where OBV is just one part of the analytical arsenal.