Stocks & Commodities V. 22:1 (20-21,24-25): Daytrading With On-Balance Volume by D.W.

Davies

Balancing Act

Daytrading With On-Balance Volume

by D.W. Davies n-balance volume (OBV) is a momentum indicator that relates price change to volume. It has proven itself over and over again as an important market trading tool for the intermediateterm investor. It is particularly useful for spotting accumulation or distribution during periods of price consolidation. Most intermediate-term investors include a study of OBV in their research of a potential stock buy or sell. However, it can also be a great aid in the rough-and-tumble world of daytrading the emini stock index futures. First, a little background on OBV. The indicator was developed by the technical analyst and market guru of yester-

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.
OBV Formula:

If todays close > previous close: Previous cumulative volume + Todays volume = OBV If todays close < previous close: Previous cumulative volume Todays volume = OBV

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Where is the smart money going? Heres how you can find out.

year, Joe Granville. He presented a detailed account of this valuable market tool in his New Strategy Of Daily Stock Market Timing For Maximum Profits. It is from this book we get the trading maxim Volume precedes price.

Stocks & Commodities V. 22:1 (20-21,24-25): Daytrading With On-Balance Volume by D.W. Davies INDICATORS

If todays close = previous close: Cumulative volume = OBV

Day1

On-balance volume is a running aggregate of volume. Volume is recorded after each trading period. When the price closes higher than the previous close, all of the volume for that trading period is considered up volume. When the price closes Day 2 lower than the previous close, all of -VE Divergence the volume for that period is considOBV ered down volume. Sell -VE Divergence The basic assumption behind Buy Buy Sell this indicator is that smart +VE Divergence Buy money knows best and leads market action. Dumb money Time knows little or nothing and follows later. This is affirmed by the FIGURE 1: USING OBV TO TRADE THE OPENING. Breakouts, breakdowns, and divergences in the OBV give indications observation that changes in OBV of where the smart money is going. precede changes in price. The assumption is that smart money can be seen flowing into an asset by a rising OBV. Conversely, entries frequently miss a large part of the days price move. smart money heads for the exit before the masses, and this Figure 1 shows how the OBV was a great help in trading the too can be observed by a declining OBV. When the public opening on days 1 and 2. catches on, moves in price and OBV will be similar. Who says they dont ring a bell at market tops and bottoms? Day 1: We see the market open without an opening gap, as If a movement in price precedes movement in OBV, a a continuation of the previous days trade an unusual nonconfirmation has occurred. Such nonconfirmations opening. The opening high the high of the first five usually occur at bull market tops (when prices rise without, minutes remained the high throughout the first 20 minutes or before, the OBV) or at bear market bottoms (when prices of trading. During that time the OBV made lower highs and fall without, or before, the OBV). lower lows, and in fact reversed from a previous rising trend The OBV is in a rising trend when each new peak is higher to a falling trend. than the previous one and each new trough is higher than the After the first 15 minutes the big upbar failed to break out previous one. Likewise, the OBV is in a falling trend when over the opening high. The OBV observation made it relaeach successive peak is lower than the previous one and each tively easy to make the decision to sell the break below the successive trough is lower than the previous one. When the opening low, the low of the first five minutes. That got us into OBV is moving sideways and not making successive highs the big move down early and with low risk. and lows, it is, to quote Joe Granville, in a doubtful trend. Just before the close, we noted that the falling trend in the The trend is your friend. Once a trend is established, it OBV reversed to a rising trend not that this is a sign to go remains in force until it is broken. When the OBV changes to long, but it is something to keep in mind for the next day. a rising or falling trend, a breakout has occurred. Since OBV breakouts normally precede price breakouts, you should be Day 2: Here we see a more usual type of opening: a signifiprepared to buy OBV upside breakouts and sell (short) down- cant gap, in this case up. About 65% of the time opening gaps side OBV breakouts. are wholly or partially closed. In addition, 65% of the time an opening gap up gives way to an up day that is, a higher OBV IN INTRADAY TRADING close. So what should you do? One of the most difficult situations in daytrading is handling the The seasoned trader waiting for the first half hour to pass opening with or without an opening gap. The opening is one of has some objective measures to work with. A little after the most volatile, emotionally driven times of the trading day and 10:00 am you can see that the rising trend in the OBV, which one of the highest-volume periods of the day. Many seasoned commenced shortly before the close the previous day, is alive traders do not trade the first 30 minutes of the session, choosing and well with higher lows. This is a signal to buy the breakout to wait until the emotions of pent-up buying or selling are spent. above 995.00. More conservative players may wait to see a On strongly trending days but who knows beforehand higher high in the OBV and get in on the long trade a few bars that a day will be strongly trending? those who avoid early later at a modestly higher price. Either way, the opening Copyright (c) Technical Analysis Inc.

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Stocks & Commodities V. 22:1 (20-21,24-25): Daytrading With On-Balance Volume by D.W. Davies

dilemma has been dealt with successfully, with a low-risk entry early in the days big move.

OBV AND MANAGING

Day 1

INTRADAY RANGES Figure 2 shows how the OBV was helpful in managing the trade after the opening on day 2. We can assume that the trade was covered sometime after 11:00 am in the 1003.001004.00 area, havDay 2 ing entered on the breakout above 995.00 after the first half hour. Then we OBV have to deal with the usual lunchtime -VE Divergence Buy fade. Sell Most days, the trade tends to move Buy sideways in a range anywhere from 11:30 am to 1:30 pm, sometimes longer. This period of range trading sets up the question of resolution. Will the move be continuation of the earlier morning trend, or FIGURE 2: MANAGING YOUR TRADE. Although a negative divergence was evident between 11:00 am and will it be a reversal? If you get the breakout 12:30 pm, the OBV never broke below the sell level. direction right, you have a pretty easy profit coming your way; get it wrong, and then be prepared to sell short on a break below this defined you could lose money. But what is worse for many traders is that price bar. when they have been blown out, they are often slow to recover More conservative players would want to see definitive and make the appropriate reverse trade. evidence of reversal and wait until the OBV broke below that Figure 2 shows how the OBV helped to resolve the range defined trough. These players would not have long to wait. dilemma on day 2. Between 11:00 am and 12:30 pm we see Once that OBV trough level was violated, there was a defined a negative divergence between price highs and OBV highs. reversal from a rising trend to a falling trend in the OBV and This may lead you to assume that a selling reversal is at hand. it was time to sell short, somewhere in the 978.00 area, shortly However, those with patience will see that the OBV negative before 3:00 pm. divergence was not a sell signal; the required reversal of the OBV from a rising trend to a falling one did not occur. OBV proved helpful in leading the The defining OBV low was not violated in that case. Prices market, and it was helpful in predicting moved to a new pullback low shortly after 1:00 pm, which is when we saw the rising trend in the OBV resume the signal the direction of breakouts. to go long. We buy the breakout above 1005.00 and are positioned to profit on the afternoon rally. Day 2 shows the transition from the previous falling trend, and finally the establishment of a new rising trend shortly OBV AND INTRADAY REVERSALS Many days there is only one dominant trend. Other days before 1:00 pm. The lunchtime fade gives way to a trend there are intraday reversals that can have a profound effect reversal, which made for a profitable afternoon going long at on your bottom line, depending on how quickly you recog- 995.00 or better. The OBV was useful all afternoon in defining nize and act on them. Figure 3 shows that on days 1 and 2, not only a continuation of the trend, but also the levels that significant intraday reversals occurred and recognizing re- allowed latecomers to join the move up with low-risk or versals in the OBV trend would have helped you profit from aggressive traders to add positions to their holdings. them. Figure 3 shows that on day 1 there was an intraday reversal WHAT THE INTRADAY OBV WONT DO that occurred after 2:00 pm. At first it looked like your garden- Correctly understood, the OBV can be very helpful to variety pullback in an ongoing uptrend. However, within three daytraders of the emini Standard & Poors 500. But be price bars from the top you can see the OBV trough was warned: using the OBV at this micro level will not prevent equalized. This also defines the price at which that OBV line sudden events from reversing your expectations. For exis drawn in the sand. At the very least you should place a ample, on days when the Federal Open Market Committee covering stop-loss at this price level. Aggressive players may (FOMC) meets and issues decisions on interest rates (around

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Stocks & Commodities V. 22:1 (20-21,24-25): Daytrading With On-Balance Volume by D.W. Davies

2:15 pm), the OBV trend prior to the announcement is not a reliable indicator of what might happen afterward. A well-established rising trend prior to the FOMC announcement may be demolished and then instantly reversed once the announcement has been made. Thus, intraday OBV can be reversed on a dime by news entering the marketplace.

* Sell Buy Sell Buy Buy Sell Buy Buy

Sell

Day 1 Day 2 In 1976 Joe Granville realized that smart * Rising trend OBV money led the field in intermediateiv Breakout i iv term stock investing. His OBV indicai ii tor helped him get a fix on what the iii Falling trend ii smart money was doing. OBV proved iii Breakdown i-iii i particularly helpful in leading the mar* Nonconfirmation ket higher and lower, and it was helpful in predicting the direction of subsequent breakouts from periods of nar- FIGURE 3: INTRADAY REVERSALS. You can see the reversal in the trend in day 2, and can clearly see areas row-range trading. At market tops and where the latecomers or those wishing to add more positions came in. bottoms, nonconfirmation of price by OBV was a trustworthy alarm. In similar ways, intraday OBV has proven to be just as helpful to off- SUGGESTED READING floor daytraders in the fast and furious emini S&P futures Granville, Joseph E., and B. Granville [1976]. New Strategy Of Daily Stock Market Timing For Maximum Profit, market. Simon & Schuster. An occasional contributor to S&C, D.W. Davies has traded futures since 1987 and daytrades the emini S&P 500 for his own account. S&C

CONCLUSION

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