According to legendary Dow theorist, Richard Russell, volume tends to expand in the main direction of the trend, and since it’s always helpful to know the direction and strength of a trend, MoneyShow’s Tom Aspray details the nuts and bolts of a leading indicator he has relied on over the years.
Volume is one of the best tools that an investor or trader can use to tell whether money is moving into or out of a stock or ETF. Regular readers know that my favorite volume indicator is the on-balance volume (OBV) that was introduced in 1963 by Joe Granville in his book Granville’s New Key to Stock Market Profits.
As I have been using it for about 30 years, it is not surprising that I have my own way of interpreting it. It can be looked at in a very simplistic manner or it can also be analyzed in depth using trend lines and moving averages. As I discussed in an earlier trading lesson OBV: Perfect Indicator for All Markets, it can often be a very good leading indicator.
In the early 1980’s before it was a popular approach I always advocated looking at multiple time frames, initially concentrating on weekly, daily, and intra-day data. After a few years, I added in monthly data, which can be very useful for determining the major trend and can be especially helpful for longer-term investors.
In this article, I would like to explain how I apply the OBV on monthly, weekly daily and even hourly data. In addition, I want to review some of the specific OBV formations that I have found to be quite reliable in both up or down markets.
The most basic level of OBV analysis is to determine whether it is following the price behavior. In other words, in an uptrend the OBV should be keeping pace with prices or leading prices higher. In a downtrend, both the OBV and price should be making a series of lower highs and lower lows.
In some instances, you will also see the formation of bullish or bearish divergences between the OBV and prices that can alert you to important changes in trend. Of course, the longer the time frame the more important and reliable the signal will be.
In a recent Charts in Play column, I reviewed the monthly OBV analysis on the gold futures contract as it has been making new highs with prices since 2002. This is the most basic level of OBV analysis but as the gold example illustrates it can be a powerful tool.