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Building a Better Mousetrap; On Balance Volume

April 2004
by Mike Kidwell
Scientifictrader.com
 

 

It has been said that if price were a train, then volume would be the steam that makes it go. That is to say, the pressure of the steam must change before the train speeds up or slows down.

On Balance Volume (OBV) is an excellent tool for measuring this steam. It has proved to be one of the best leading indicators of price movement and is invaluable in providing insight regarding accumulation and distribution. OBV was originally created by Joseph Granville. It reflects a running total of volume as reflected by a change in closing prices.

When the closing price is higher than the day before, the volume for that day is added to the running total, when it is lower, the volume for that day is subtracted from the running total.

The short fall of OBV is that it generalizes. The change in price is irrelevant and only the direction of change is taken into consideration for the calculations. To overcome this short fall we need to account for where the price is headed in relation to the total price movement (highs and lows) before we attribute any volume to it. When we do this, the effectiveness of this indicator greatly increases. Look at the chart below of AMSC. The top window represents price. The middle window (red indicator) is where OBV is calculated Grands way and the bottom window (blue indicator) is calculated taking into account all price movement and apportioning volume accordingly.

Notice in the chart above how the price peaks on September 14th , as indicated by the yellow vertical line. Then on September 19th the OBV exceeds its last peak, giving promise of rising prices to continue. The “enhanced” OBV method though, peaked the same day as the price and has started to fall, giving a clear warning that the price indeed, is about to change direction.

Lets try one going in the other direction. Lets see how we can get an early detection of rising prices. Look at the chart below of AMSG.

Notice how the price bottoms out on January 9th, as indicated by the yellow vertical line. At this point, Grands OBV is still in the hole. The enhanced OBV however, is in the process of creating a second higher trough, creating a convergence between OBV and price, indicating an upward breakout.

Often times this enhanced method of calculating OBV will run concurrent with Grands method, but when the market appears to be indecisive, it is less likely to give reason for hope where hope doesn’t exist and is more likely to identify a positive change in direction when that change is not apparent as shown above.

How can you enhance your OBV indicator like the one above. First, you need charting software that will allow you to build your own indicators, such as Amibroker charting software. I have found it to be a great value. You can check it out for yourself at http://www.amibroker.com Then you need to calculate the following information.

Cumulative total of (volume * ((high-open) / (high-low))) -

Cumulative total of (volume * ((open-low) / (high-low)))

What we are doing here is assigning a percentage of the volume to upward and downward movement based upon the percentage of price movement in the same direction.

To build this indicator using the Amibroker language, you can paste the following into your indicator window:

myobv=Cum(V*((H-O)/(H-L)))-Cum(V*((O-L)/(H-L)));

Graph2=myobv;

Graph2Style=1;

Graph2Color=6;

OBV deserves a much more in-depth discussion than is presented here and understanding volume is only one aspect of successful trading. The purpose of this page is to show how we can take a tool and get much more out of it to gain an advantage that will allow us to compete successfully against other traders! Did I say compete? Yes! When trading, you must keep in mind that every transaction is a battle of sorts. At least one party will always get the short end of the stick. FACT: 90% of all stock profits are made by only 10% of those engaged in stock trading. If you want to be in that 10%, then you need to be equipped with superior knowledge as outlined above. If you’re ready to take on the winning 10%, click here.

 

KNOWLEDGE IS POWER

Recommended Reading

IMAGINE this…You have just boarded an airliner for a cross country flight. Just when you are comfortable, you notice the pilot walk past you with a book in his hand. As you look closer, you notice the title, “Learn How To Fly”! At this point, your confidence would probably sink to the floor and you would be wondering who was responsible for letting this guy fly the plane. Yet, this is what many do in the trading world. Before they understand how this “machine” called the stock market works, before they understand the significance of different indicators, time frames, etc., they jump into the cockpit and start risking their hard earned cash.

There is a safer way. Learn first and learn from the best! There is an excellent publication for new traders. It’s called, “Trading For Beginners”. It is masterfully written by one of the foremost trading minds around, Mark Mcrae. He is a full time trader and lectures to individuals and institutions alike throughout the US, Great Britain, Cyprus and Canada. Every question people are too afraid to ask is answered in this fantastic book. People normally spend $3000 a day on McRae's rare lectures.

To learn more about this incredible publication, click on the following link.

http://tradingforbeginners.com

Best regards,

Mike Kidwell

Scientifictrader.com

Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our disclaimer.

 




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