Most price based indicators are lagging and we only get a signal after the price has moved. Can OBV predict price movement before it happens?
What is the OBV indicator and how does it work?
As far as I am aware, the On-Balance Volume, or OBV, was first described in the 1963 book New Key to Stock Market Profits, by Joseph Granville. The concept behind OBV is that the volume of the asset traded is what drives the change in price. This implies that it may be possible to use volume anaysis predict price direction.
Before going further, it is important to mention that true volume traded can only be known for assets such as stocks and shares, where:
- There is a known quantity of the asset (e.g. shares issues);
- The asset is traded via a centralised stock exchange.
Unfortunately, the forex market, which is decentralized cannot provide true volume information. As retail traders, we are only able to get real-time information on Tick Volume, which is the number of transactions known to our broker. However, some researchers have found that there is some correlation between Tick Volume and True Volume especially with larger brokers whose platforms have visibility of a large number of transactions.
So, limitations aside, what might we be able to tell from volume? I won’t attempt to cover all the theory here, but here are a few concepts to consider:
- The close price of a chart candle only tells us the price of the last transaction. Within that candle, there might have been more interest (volume) in the price moving up or down, but this is information is hard to see.
- If we could detect this bias in volume, this might be useful for predicting an price movement.
How does the OBV PIN use On-Balance Volume?
At first glance, the OBV indicator (below) bottom appears to be following the trend. However, when we add a moving average (21-SMA) to the on-balance volume signal line we can see something very interesting: whilst the price appears to be moving sideways in a range, the On Balance Volume has crossed its moving average and is moving down. Put another way, there is a divergence between volume and price information, which might predict an impending price correction. In the image (which is taken from EURGBP H1) we can see that the signal MA cross does indeed precede a significant price movement.
Using the On Balance Volume Indicator PIN
If you are familiar with my other PINS, setting up the OBV PIN should be quite straight forward.
- For each timeframe, you can select one of three modes: Disabled, Direction, or Crossing MA. In Disabled mode, the timeframe is ignored. In Direction mode, if the OBV is above its MA a buy signal is generated, and a sell signal if the OBV is below its MA. In Crossing MA mode, a buy signal is generated when the OBV crosses the MA upwards, and a sell signal when the OBV crosses down.
- The OBV calculation can be fine-tuned by selecting the Applied Price, which can be one of High, Low, Open, Close, Median, Typical or Weighted Close. The default is Close Price.
- The MA period can be adjusted to any positive integer.
- Finally, you can select if the signal is on the Current bar (shift = 0) which might repaint giving an earlier but more dynamic and possible multiple signals, or on the Closed Bar ( shift = 1) giving a more stable signal.