Wednesday, June 10, 2009

About Volume and On-Balance Volume (OBV)

I have been writing about the importance of transaction volume for confirmation of stock or index chart pattern moves. Price rise should be accompanied by higher volumes. Price falls should be on lower volumes.

Rising price on static or lower volumes produces a 'negative divergence' - which indicates the rise may end soon. But what if the stock price or index is moving sideways and the volume is going up, or down? Does that have any technical significance for market movements?

Enter the concept of 'On-Balance Volume', a momentum indicator developed by Joseph Granville in 1963. It is calculated on the basis of a rather simplistic assumption about the closing price of a stock, or the closing level of an index:

If the closing price or index level of a particular day is higher than the immediately preceding trading day's, then the entire volume of transactions is added to a cumulative volume total (named On-Balance Volume, or OBV).

If the closing price or index level is lower than the immediately preceding trading day's, then the entire volume of transactions is subtracted from the OBV.

If the closing price or index level of a particular day remains unchanged from that of the immediately preceding trading day's, the OBV also remains unchanged.

What is the significance of this momentum indicator? A rising OBV means accumulation (i.e. the entry of smart-money); a falling OBV means distribution (i.e. stronger hands transferring their holdings to weaker ones).

Why is the calculation of OBV simplistic? A stock or index usually has several up and down movements throughout the trading day. On a higher closing day, the volume of all buy and sell transactions are added to the OBV. Logically, the total volume of all sell transactions should be subtracted from the total volume of all buy transactions before adding to the OBV.

Likewise, for a lower closing day, the difference between the total sell volume and the total buy volume should be subtracted from OBV. When the indicator was developed by Joe Granville, computers were not as readily available or accessible. So to keep matters simple, logic was given short-shrift.

Let us look at an example. What better choice than the BSE Sensex index chart pattern?

Sensex_OBV1009

During Sept '08 and Oct '08, the OBV followed the Sensex downwards. In Nov '08 and Dec '08 also, the OBV danced together with the Sensex in lock-step.

Now comes the interesting part. See what happened during Jan '09 and Feb '09. While the Sensex fell, the OBV remained flat. A positive divergence, indicating a possible trend change.

Also interesting to observe is what happened when the rally took off during Mar and Apr '09. The OBV made a higher top in Apr '09 when the BSE Sensex index was at around 11000, than when the index was at 16000 in Aug '08. This was a true sign of accumulation.

Unfortunately, this particular charting software doesn't have volume information updated from May '09 onwards.

I would like to thank reader Rajeev for asking a question about accumulation and distribution in the 'comments' thread of this post. It motivated me to write this article.

Related posts

A rectangular Sensex chart pattern
Three phases of a Bear Market
Sensex in a narrow band

15 comments:

vineet said...

Hi Subhankarji,

I am a regular reader of your blog and your comments on the ISG forum. I must say your have one of the best blogs on the Indian markets. (I havent come across a better one)

Please keep sharing and guiding us.

Thanks very much.

Vineet.

Subhankar said...

That is high praise, Vineet. Not sure if I fully deserve it.

It is a pleasure to share my investing experiences with readers like you. If you have any queries - stock-specific or general - feel free to send me an email.

Thank you for the kind words.

chalukya said...

Hi Subhankar ji,

Here's the link on OBV as on today from icharts.in http://www.icharts.in/charts.html

Your analysis is really helping me in predicting market movements.

Raghavendra

Subhankar said...

Appreciate the link, Raghavendra.

I've learned the hard way (i.e. by losing money) that predicting the movements of Mr Market is very difficult, if not impossible. So nowadays I just monitor the charts, write about my observations, and try to remain nimble.

Glad to be of help.

Eswar Santhosh said...

(Thanks to Raghavendra's Link)

Interestingly, OBV has hit a new high based on 3-month Nifty Charts at 154.7. It was down in May to near Zero around 4200 in Nifty.

For Sensex, it has more or less remained flat around April levels till May was about to end. To my untrained eye, that looks like 11,200 to 13,800 (I was selling at both points. May be I was "distributing"? ;-))

From that point on, there has been a spectacular run-up both in Sensex and OBV.

I tried a few Vol indicators in the chart and found Williams %R. Strange name attracts strange people like me :-) It shows Sensex is in overbought zone. (For people like me, William is -8.2 and anything above -20 is overbought and below -80 is oversold).

Money Flow Index, another Indicator I tried also is approaching the overbought territory (78, OB is 80). Interestingly, this also was well below overbought territory from 11,200 till now.

On the contrary, RSI has remained near or above Overbought levels of 70 for all three months.

My sentiment indicator is a little down as people are selling entire portfolios. Sensex usually charts a different course to this Index. But, do not know if consensus and correction can come together in the coming days.

Now that the rookie has lined up everything, may be the expert should explain whether Sensex will crash or correct or still go up :-)

adarsh said...

I have started reading your blog recently and find it very informative.Subhankar ji can you give us some examples of how to use indicators in intra day charts

Subhankar said...

@adarsh: Thanks for your comments.

I'm the wrong person to ask questions about intra-day trading. I vehemently oppose it because it is akin to committing financial suicide. The odds of success are negligible. Only a handful of very experienced traders make money by trading intra-day.

But if some one is planning to commit suicide, s/he will probably do it anyway. There is no harm in giving a push in the right direction.;-)

Visit my friend Pankaj's blog at http://pankaj564.blogspot.com. He may be able to answer your question better.

@Eswar: Sorry, I won't let you trap me into a prediction about Sensex moves! My observations about Sensex movements will appear as usual on Saturdays.

My personal preference is for the slow stochastic oscillator, along with the MACD, RSI, ROC and OBV. These, along with the volumes and 20/50/200 day EMAs are all the complications that I can fathom.

It is important to use the indicators that work for your style of investing. A certain amount of trial-and-error is involved, since one size may not fit all.

Williams %R is very similar to the stochastic oscillator. The MFI has similar function to OBV. Indicators can remain overbought or oversold for long periods.

If the OBV is rising, stop worrying about the index or stock level. Keep setting trailing stop-losses as the level/price moves up and then sell as soon as your stop-loss is hit. Whether you want to sell all, or a small percentage has to be your call.

ravinder said...

Respected Subhankarji,
I am in touch with stock market since last 2-3 years.But overall I am a looser as far as stocks are concerned,inspite of my investing after lot of studies-the reason being buying at higher price level.
Here lies the importance of Technical Analysis-which gives idea of entry/exit level.
Basically I am BE(Mechanical)and capable of learning Technicals with time.
I shall be highly grateful if some basic book on technical analysis is recommended for beginers like us.
regards,
Ravinder Kr Arora.
ravinder48a@gmail.com

Subhankar said...

Hi Ravinder

Losing money in the stock market is part of the learning process. I've written about it in a couple of blog posts in Jun '08.

A list of books - on fundamental and technical analysis - was provided in a blog post on Jun 17, '08 (you can click on 'Jun 2008' in the 'Blog Archive' window near the bottom of the right panel).

A 'slideshow' on top of the right panel has some books listed. Feel free to contact me with any specific queries.

Green Equities said...

Dear Subhankarji

I have been regularly reading your articles posted on the AIII group.
The current article about OBV is very informative and helpful for me.

I will appreciate if you can send a line in reply telling where (name of the site) OBV data can be obtained for Nifty?

Subhankar said...

Appreciate your comments, GE.

You can visit icharts.in and rupeeking.com for charts and various technical indicators.

The Visitor said...

Hello Subhankar,

As usual a very informative post from you. Though there are numerous sites that give the current values and charts for the various indicators, I usually prefer to compute them myself.

In this instance (OBV) I'd like to know:
-if there is any standard formula for calculation?
- where (when) should one fix the starting point for calculating this indicator, as I presume that this is cumulative/moving indicator.
-When one computes OBV for the market, does one calculate the OBV using total market or does one use the advances/declines ratio.

Does one need to do any normalization of the data in the computation?

Subhankar said...

Thanks for your comments.

The absolute value of the OBV chart is less important, as the starting point can be random. It is the plot of a cumulative total which is supposed to have a pattern broadly similar to the stock or index.

It is only of interest to us when there is a divergence between the OBV and the stock or index being charted.

No data normalisation or A/D ratio is necessary. Just a simplistic and straightforward addition and subtraction from a total.

Nasir Khambatta said...

Hi Subhankar,

I read this post today. You said:
"Logically, the total volume of all sell transactions should be subtracted from the total volume of all buy transactions before adding to the OBV.

Likewise, for a lower closing day, the difference between the total sell volume and the total buy volume should be subtracted from OBV."

The difference between the total sell volume and the total buy volume will always be zero because each sell transaction is also a buy transaction. Could you explain what you meant? Thanks.

Subhankar said...

Good question, Nasir.

You are quite right - the total buy volume and total sell volume has to be the same at the end of each day.

Let me try to explain what I meant with a simplistic example. Let us say on a given day for a particular stock, there are 3 buyers wanting to buy 400, 300, 300 shares respectively. There are two sellers - one wants to sell 600 shares and the other 400. The total buy volume is 1000, and the total sell volume is 1000.

Since there are more buyers than sellers, the price of the share is likely to end up higher at the end of the day. It is quite possible that if the 3rd buyer hadn't placed his order for 300 shares, the share's price would have been lower than the previous day's. But, as per OBV rules, the entire 1000 shares are added to the OBV total of the previous day.

It may be more realistic to set off the first two buyers against the two sellers, and only add the 300 shares of the third buyer to the OBV total.