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 doesnt 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:
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