Indicator in Focus: On-Balance Volume

05/02/2012 3:00 pm EST

Focus: TOOLS

Thomas Aspray

, Professional Trader & Analyst

By analyzing the trend of the on-balance volume (OBV) indicator, traders can spot important early signs of buying or selling in equities and a host of other markets, explains Tom Aspray.

My guest today is Tom Aspray, and we are talking about on-balance volume and how he uses that to find good opportunities. So Tom, first of all, define what OBV is.

OBV was developed by a technician who is still giving market analysis at 88, Joe Granville, who I have had the pleasure of meeting several times. Essentially, it is a cumulative total. If a market or an index closes up, it adds in the volume; if it closes down, it subtracts that volume, and it keeps a running total of those numbers.

The actual numbers are not important, but it is the trend of the on-balance volume that’s important.

In January 2012, a lot of people were skeptical of the stock market rally, so the volume was lagging. If you look at a volume chart of the Spyder Trust (SPY), you’d see that prices have been going up and volume has been going down.

But if you look at the volume patterns of individual stocks, and particularly the on-balance volume, you will see that there are signs of accumulation.

One thing I love about the on-balance volume is it will often act stronger than prices, so it will make a new high ahead of prices, suggesting there is power behind that move.

It is one of the tools I look at first on a weekly basis, and it is really good. For a stock like McDonald’s (MCD), the weekly on-balance volume is still positive, but it turned positive around last March, and so you can get some really major trends.

It is available on most platforms, and I juiced it up a little bit by adding a weighted moving average to it because that gives me another idea of what the trend is.

So Tom, there are so many things you can put on a chart to get an idea of where something is going, and your favorite is the on-balance volume. How do you get to the point where you are comfortable maybe using one or two, but not getting overwhelmed by all of the information?

It takes a while, and for some people, on-balance volume may not be their cup of tea. I wrote an article many years ago for a London publication about the directional movement index, which is another of Welles Wilder’s indicators.

Some guy wrote me about how much money he was making in the bond market just using that. I wrote him back and, truthfully, I said I don’t have enough confidence in that one indicator to use it, but if you do, and you’re acting successfully on it, that is what is important.

Does the on-balance volume indicator work well within a specific sector, specific stocks, or how do you like to apply it?

It works in almost everything as long as it is liquid enough. I use it for my stock selection, but I also use it in terms of my sector selection, and in the Select Sector SPDR ETFs. It also gives you a good idea of risk, which is an important part of my writing.

I find lots of markets I like, but I have to buy them at a certain level, which means I miss a lot of trades. If I have to risk more than 10%, I’m not going to recommend anything at that price level, and so it can give you a good advance warning.

If the market starts to move up and the on-balance volume starts to move down, that is the time when you want to tighten your stops.

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