I hope you’ve enjoyed reading this series on trading with indicators so far as much as I’ve enjoyed writing them.  In this penultimate edition of the series and the next one, I want to focus on a couple of indicators that haven’t been discussed so far.

This week, I want to turn your attention to the On Balance Volume (OBV) indicator first.It’s one of the few momentum indicators out there that can relate price change to volume. It is particularly useful for spotting accumulation or distribution during periods of price consolidation.

Background

The indicator was developed by the technical analyst and market guru of yesteryear, Joe Granville. A detailed account of this valuable tool is presented in his book “New Strategy Of Daily Stock Market Timing For Maximum Profits”. It is also from this book we get the trading maxim “Volume precedes price.”

Calculation

On-balance volume is calculated by adding the volume to a cumulative total when price closes up, and subtracting the volume when price closes down. If there is no price change, there is no change made to the OBV cumulative total. It is a running aggregate of volume as shown.

OBV Formula:

If today’s close > previous close: Previous cumulative volume + Today’s volume = OBV
If today’s close < previous close: Previous cumulative volume – Today’s volume = OBV

The indicator tells us that“smart money” knows best and leads the market. This is confirmed by the observation that changes in OBV precede changes in price.  The moves in price and OBV will be similar.

Rising Trend: OBV and Price → Both make higher highs and lows
Falling Trend: OBV and Price → Both make lower highs and lows
Doubtful Trend: OBV sideways

When the OBV changes to a rising or falling trend, a breakout has occurred. Since OBV breakouts normally precede price breakouts, you should be prepared to buy OBV upside breakouts and short downside OBV breakouts.

     OBV in Intraday Trading

You can study this 15 minute chart of VOLTAS to further understand the above concepts. One can definitely explore trading by observing negative divergences and analyzing charts. However, it is a challenge to automate these strategies.

Comparing OBV with Volume

Another important study done with OBV is to compare it with a volume bar. When the volume of a candle is much greater than the OBV after a sustained trend has occurred indicates a possible trend reversal. This needs to be combined with another indicator to confirm the signal.

Next, let’s take a look at Williams %R before we see how it can be used in conjunction with OBV.

Williams %R

Williams Percent Range or simply %R, gets its name from its developer Larry Williams. It is the inverse of the Fast Stochastic Oscillator.

The Fast Stochastic, if you remember, is calculated by comparing the current price with the low of the look back period. %R in contrast, compares the current price with the high.

As a result, the Fast Stochastic Oscillator and Williams %R produce the exact movement, only the scaling is different. %R oscillates in the scale between 0 to-100, where-20 is the overbought level and-80 is the oversold level. Williams %R corrects for the inversion by multiplying the raw value by-100.

How this indicator works

  • -50 is the midpoint. When %R crosses above -50 signals that prices are trading in the upper half of their high-low range for the period (bullish). Conversely, a cross below -50 means prices are trading in the bottom half of the (bearish). It is clearly seen in the chart for BATAINDIA.
  • Readings above -20 indicate that the instrument is trading near its 14-day high-low range. Readings below -80 occur when it is trading at the low of its high-low range. Default settings use -20 as the overbought threshold and -80 as the oversold threshold. These levels can be adjusted depending on the security’s characteristics.
  • When % R does not rise in tandem with the price or %R does not fall in line with the price, it is said to show a negative divergence. These signal a possible reversal in the current trend as seen in the chart for BATAINDIA. However, keep in mind that even though a security is overbought or oversold it can remain in this state for an extended period of time.

    Learning To Use OBV & WilliamsR

Trading System with On Balance Volume (OBV) & Williams %R (%R)


1) Long Entry
A long entry should be made when these conditions are met:

15 mins Chart
1. OBV has a upward breakout - Set Breakout levels for individual stocks based on the chart AND
2. %R (14) is above -70 AND
3. A Green Candle

Stop Loss
The previous swing low

Target
Once a profit equal to the size of the stop loss is crossed, move stop loss to breakeven and trail with 1x the stop loss. Consider booking gains if a target of 3x your stop is reached.

2) Short Entry
A short entry should be made when these conditions are met:

15 mins Chart
1. OBV has a downward breakout - Set Breakout levels for individual stocks based on the chart AND
2. %R (14) is below -30 AND
3. A Green Candle

Stop Loss
The previous swing high

Target
Once a profit equal to the size of the stop loss is crossed, move stop loss to breakeven and trail with 1x the stop loss. Consider booking gains if a target of 3x your stop is reached.


The HAVELLS 15 min chart below shows you how to look for a negative divergence in OBV and time your long and short entry.

A buy is triggered at 10.15 AM on 14/08/2019 after the OBV shows a negative divergence, followed by a confirmation in %R and a green candle in the price. The entry price is 649.80 with a stop loss below 642.  The stock moves higher and one could book profits once the stock crosses 675 or trail below it.

The short sell is triggered at 2.30 PM on 20/08/2019 after the OBV has a breakdown after the negative divergence earlier. This is confirmed by %R and price. We short at 679.80 with a stop loss above 687.

The stock does a temporary blip up, but saving our stop loss by a whisker before tumbling downwards. Veteran traders always recommend keeping stop losses at a few ticks above or below swing highs and lows to protect against these types of fake out moves.

Limitation of Alerts with OBV

Generic alerts can be set only for the %R condition of the strategy. You will need to observe the candle and OBV once your alerts are triggered before taking your trade.

Closing Notes

Though setting Alerts across stocks with OBV is challenging, it is particularly helpful in leading the market higher and lower, and helps in predicting the direction of subsequent breakouts from periods of narrow-range trading. At market tops and bottoms, non confirmation of price by OBV is a trustworthy alarm. In similar ways, intraday OBV can provide cues to improve your entries and exits.

Do explore with the OBV with weekly charts on your investment stocks to track Smart Money and improve the timing of your investment portfolio purchases.