The Power of OBV in Forex Trading
One of the secrets of winning your forex trades is realizing the power of volume indicators. But how do you apply volume in forex trading?
There are many ways to determine volume-price relation in forex. The best route is to use the On-Balance-Volume indicator.
This article explains the kernel of OBV. Here, you will learn a brief background of OBV, calculation, and interpretation. Lastly, you will find out when to use it. Let’s get started.
Background of OBV
Having studied the market for some time, Joseph Granville deduced that volume precedes price movement. He went ahead to create OBV to let other traders apply his findings.
OBV is a technical indicator that applies volume to project changes in forex price.
It tracks the positive and negative volume trading volume to tell the buying or selling pressure on a forex currency pair. On a chart, the candlesticks hang above the OBV.
To be able to tell volume, OBV must incorporate the powers of trend and momentum indicators.
A trend indicator tells when prices are likely to change owing to past data. Using past data, trend indicators present you with a histogram.
Examples of trend indicators are Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Bollinger bands, and Average Directional Index (ADX).
On the other hand, momentum indicators tell you the rate at which the price is changing. Typical momentum indicators are MACD, RSI, and ADX.
Using a volume indicator enables you to realize the sales or purchases made of the currency pair. The most typical volume indicators are Chaikin money flow, OBV, and Klinger oscillator.
Calculations and Interpretation of OBV
On-Balance Volume is a cumulative indicator. This means that the present values are derived from the previous readings.
If the current price bar closes higher than the previous price, take the current volume and add to the previous OBV value.
OBV = Previous OBV + Current Day’s Volume
If the current price bar closes lower than the previous one, take the period’s volume and subtract it from the previous OBV readings.
OBV = Previous OBV – Current Day’s Volume
If the price’s current close is the same as the previous day’s close, the OBV value does not change.
OBV = Previous OBV
Assume we have a chart with five candlesticks. The first candlestick has a rising price with a volume of 120. Here, the OBV is 120 because it starts the chart.
The second candlestick is bullish with a volume of 150. Since its price closed above the previous one, its OBV becomes 120 + 150 => 270.
The third candlestick lacks a body. Meaning, its closing price equals the previous (second) candlestick’s price reading. The candlestick has a volume of 100.
Since there is no rise or fall in price, the OBV value does not change. Therefore, your OBV for the third candle remains at 270.
The fourth candlestick’s price closes below the third candlestick’s reading and has a trading volume of 70. It is known as a bearish candlestick. To get its OBV, subtract 70 from the previous OBV. That’s 270 – 70 => 200. The resulting OBV is 200.
Lastly, the fifth candlestick is bearish with a volume of 100. Since its price is below the previous (fourth) candlestick’s reading, subtract its trading volume of 100 from the previous OBV of 200. The resulting On-Balance-Volume is 100.
Since the OBV values rely on previous readings, they are not absolute. So, you should not focus on the values shown but the trend direction if you want a solid conclusion.
Although it considers a range of price change, its strength lies in value. A massive volume spike can make the indicator’s values go off for some time.
Therefore, it would be helpful to grant the OBV some time to settle during a spike before applying it in your forex trading decisions.
Use OBV when you want to forecast breakout direction for a ranging market. Here, the prices neither rise nor fall but lies between support and resistance levels.
It is also crucial in forecasting market reversals, support, and resistance levels. To realize the full potential of OBV, combine it with trend and momentum indicators.