As already mentioned above, OBV shows the cumulative flow of volume for a particular asset to determine the shifts in market interest and sentiment towards the asset.

This can range from singular assets, to a basket of investments and indexes.

Calculation

The OBV is calculated by adding the volume of an asset to the indicator when the price closes higher (indicating buying pressure) and subtracting the volume when the price closes lower (indicating selling pressure).

If the closing price is unchanged from the previous period, no volume is added or subtracted.

• If the current closing price > previous closing price, OBV = Previous OBV + Current Volume
• If the current closing price < previous closing price, OBV = Previous OBV - Current Volume
• If the current closing price = previous closing price, OBV remains unchanged

Interpretation

Traders and analysts use OBV to confirm trends. Rising OBV suggests that buying pressure is increasing, which may indicate a bullish trend.

Falling OBV suggests increasing selling pressure and may indicate a bearish trend.

Divergences between the OBV and the price of the asset can also be used to identify potential trend reversals.

Volume Confirmation

OBV is often used alongside price analysis to provide confirmation of price trends. For example, if a stock is in an uptrend, traders may look for rising OBV as confirmation that the buying pressure is indeed increasing and supporting the price movement.

By confirming this, traders can also use other technical indicators in conjunction with OBV to pinpoint an entry price that has the most potential of delivering profits. 

Volume Breakouts

Traders also use OBV to identify potential breakouts. A breakout occurs when the OBV moves in the opposite direction of the price trend.

For example, if a stock is trading in a range, and OBV starts rising while prices are still within that range, it may signal an upcoming breakout to the upside.

Divergences

OBV can be used to spot divergences between the indicator and the price chart. For example, if the price of a stock is making higher highs while the OBV is making lower highs, it could be a bearish divergence, suggesting that the price trend may weaken.

Divergences are important to consider when using OBV, as it can potentially signal the end of one trend and the beginning of a new one. 

Using on-balance volume in trading comes with its fair share of advantages and disadvantages. Traders need to consider these factors carefully before relying on the indicator for trade signals. 

Pros

• Confirmation of Price Trends: OBV can be a useful tool for confirming the strength of price trends. When the OBV aligns with the direction of the price movement, it provides confidence to traders that the trend is supported by healthy buying or selling volume
• Early Warning Signals: OBV can provide early warning signals of potential trend reversals or breakouts. Divergences between the OBV and price can signal that a trend may be losing strength or reversing, allowing traders to make informed decisions ahead of time
• Simplicity: OBV is relatively easy to understand and calculate. It doesn't involve complex mathematical formulas, making it accessible to both novice and experienced traders. This simplicity can lead to quicker analysis and decision-making

Cons

• False Siglas: OBV, like many technical indicators, is not immune to false signals. It can produce whipsaw signals during periods of low volatility or in choppy markets, leading traders to make incorrect trading decisions
• Limited to Volume Information: OBV primarily relies on volume data and doesn't incorporate price directly. This limitation can result in situations where OBV appears strong, but price trends are weak or vice versa, leading to misleading signals
• Subjectivity: Interpreting OBV signals can be somewhat subjective. Traders may have different criteria for identifying divergences or trend confirmations, leading to variations in how the indicator is used and potentially causing confusion

• Traders use technical indicators to gather data from the market and make trade decisions
• OBV, or on-balance volume, is a popular indicator that measures the flow of capital in and out of financial instruments
• Traders sue OBV to identify bullish and bearish trends by measuring the growth and decline of trading volume 
• A rising OBV may indicate an upcoming bullish trend, while a falling OBV shows a bearish turn 
• OBV is frequently used alongside other indicators, such as moving averages and oscillators to generate more reliable signals