November 12th, 2008

Resurrecting OBV (On-Balance Volume)

As the market plummets today again more over 5% and approaches what I have considered a critical resistance trendline, my eye focuses on the On Balance Volume (OBV) indicator inserted over the volume section of the chart.

OBV was invented by Joseph Granville back in 1963 and popularized by him in the 1970’s. Do you remember Joseph Granville? For those who don’t, Granville became famous for his bearish and flamboyant market calls during the 1970’s, 1980’s, and 1990’s each time claiming that the stock market was headed for imminent collapse. He also claimed to have called the crash of 2000 within 24 hours of it’s March 10 NASDAQ peak of 5048.

Good Ol’ Joe comes to mind because I had embraced OBV as the a key for realizing my stock market dreams in the 60’s and 70’s (when I first got started with graph paper and pencils, a long time before PC’s) primarily because of its simple calculations. According to Stockcharts.com:

“The concept behind the indicator: volume precedes price. OBV is a simple indicator that adds a period’s volume when the close is up and subtracts the period’s volume when the close is down. A cumulative total of the volume additions and subtractions forms the OBV line. This line can then be compared with the price chart of the underlying security to look for divergences or confirmation…..

The idea behind the OBV indicator is that changes in the OBV will precede price changes. A rising volume can indicate the presence of smart money flowing into a security [or market]. Then once the public follows suit, the security’s price will likewise rise.

Like other indicators, the OBV indicator will take a direction. A rising (bullish) OBV line indicates that the volume is heavier on up days. If the price is likewise rising, then the OBV can serve as a confirmation of the price uptrend. In such a case, the rising price is the result of an increased demand for the security, which is a requirement of a healthy uptrend.

However, if prices are moving higher while the volume line is dropping, a negative divergence is present. This divergence suggests that the uptrend is not healthy and should be taken as a warning signal that the trend will not persist.”

OBV has pretty much been discredited as being outmoded – sort of like Betamax and cartridge audio tapes and typewriters. But I saw something in OBV’s performance during this bear market crash that might give us a clue to actually seeing a turn as it happens (please click to enlarge)?

Every upleg of this bear market has been preceded and accompanied by a surge in volume. Since mid-October, volume has been continuously decreasing. The market can’t bottom and start moving up, even if it’s just a modest correction (+25-30%) unless those rare and infrequent up-days are accompanied by higher than average volume – that’s when the OBV can start to trend up.

Now we know what to look: higher volumes on those rare up-days.

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