Introduction
As you traverse the Indian stock market, especially liquid indices such as Nifty, Bank Nifty, and large-cap stocks on NSE/BSE, tools such as the on-balance volume indicator can provide a trading advantage. What is on-balance Volume? On balance volume is a momentum indicator that also uses volume changes to forecast price changes. It provides you with insights into the market's strength in addition to the price trend.
Dissecting the On-Balance Volume Indicator
It was in the 1960s that a single trader, Joseph Granville, could revolutionise traders' understanding of accumulation and distribution. If you are tracking a stock like Tata Motors, the OBV measures trading volume on any given stock, where it adds the day's Volume on days the stock price closes higher than the day before, and subtracts the day's Volume on days that it closed lower than the previous day. Therefore, the OBV provides a cumulative line of the implied market buying or selling pressure, which often indicates buying and selling trend strength before the price charts show any price trend.
Understanding the On-Balance Volume Formula
To use the on-balance volume formula, designate an initial OBV value (typically 0, or the Volume of day 1) for every trading day, then:
Calculating OBV is straightforward:
- If the closing price today is greater than yesterday's, OBV = Last OBV + Volume today
- If the closing price today is less than yesterday's: OBV = Last OBV - Volume today
- If the closing price is unchanged: OBV = Last OBV
With this basic mathematical calculation, you have a plotable line that you typically can plot with price charts. For instance, if OBV is increasing and a stock like Reliance Industries is range-bound consolidating, that is consistent with accumulation and should give you some perspective on potential future breakouts.
Start your investing journey today!
Using OBV in Indian Markets
The Indian markets are volatile, with many stock-driven organisational events (such as budget and other announcements) appearing; there are signals like OBV trading that can help traders synthesise that noise. Following on balance volume signals that you have a directional confirmation in strength, with a stronger trend likely to appear. For example, if we are talking about buying and the OBV is increasing along with the price in a stock like any bank, you have a bullish confirmation at the time to either hold or add to your position.
On-Balance Volume Trading Applications
There are two common ways to use on-balance volume (OBV) trading applications
- Trend Confirmation: Your trade is typically free of doubt when the OBV moves in the same direction as the price. So, if OBV is in an upward direction with the price rally on the Sensex at the time, that indicates that volume is stronger, indicating buying.
- Divergence Detection: If a stock's price increases while its OBV stays flat or decreases, this bearish divergence could indicate that a reversal pattern is developing. A rising OBV and flat prices may imply an imminent protracted upward movement.
Another approach is breakthrough confirmation. If the MCX gold futures contract experiences a breakout above a resistance level and the OBV is rising in the breakout, it would certainly give more confidence in the breakout, noting that there can be a volume shift with the rollover of the contract.
Practical Examples of OBV Trading
Imagine you're trading Infosys at ₹1,800, with resistance at ₹1,850. In the span of just a few days, the OBV line and price have both sharply risen, with the price breaking through the resistance. It signals strong accumulation, indicating a potential big move up is coming. You buy at ₹1,900, and you are comfortable with your pursuit.
On the other hand, if, for example, you are trading crude oil futures and the price has risen to ₹5,500 but your OBV is moving downwards, this OBV divergence depicts a potential pullback, and you would feel comfortable selling short.
The OBV Indicator Limitations
Although the OBV indicator is a strong trading aid and helps traders better process and understand price and volume activity, it has limitations. The OBV indicator often gives unreliable signals with low-volume stocks, which may be more common with smaller Indian companies. The OBV indicator does not convey how much the price has changed, so with volatile price activity following earnings, the OBV indicator should only be used in conjunction with fundamental analysis to provide the most accurate signals.
Conclusion
As an Indian trader, using the on-balance Volume as part of your strategy allows you to understand how trading volume connects with the price movement of a security. Regardless of whether you are a novice looking into stocks from the NSE for the first time or an experienced trader, OBV trading will help you make intelligent trading decisions. At Motilal Oswal, we suggest you practice on demo platforms and always mix your OBV trading with risk management and discipline to convert your thoughts into profits. Start your trading charts and raise your trading profile today.
Similar Reads: Understanding Trading Volume: Its analysis and interpretation | 5 Technical indicators you can use to improve your trading profits | The psychology of Trading: How to use technical indicators