# On-Balance Volume (OBV): How It Works and How to Use It

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## What Is On-Balance Volume (OBV)?

On-balance volume (OBV), developed by Joseph Granville in 1963, is a pivotal technical trading indicator that leverages [volume](https://www.investopedia.com/terms/v/volume.asp) flow to anticipate stock price movements. Granville proposed that market volume is the driving force behind significant price shifts. His OBV metric aims to forecast when major market moves will occur based on changes in volume. According to Granville, when volume rises sharply without a corresponding price change, an eventual significant price movement is likely—either upward or downward—due to this 'spring being wound tightly' effect.

### Key Takeaways

*   Volume Drives Price Action: On-Balance Volume (OBV) is a momentum indicator that uses trading volume to anticipate changes in stock prices. It signals potential price movements based on volume shifts, as volume typically precedes price action.
*   Smart Money vs. Retail Investors: OBV helps distinguish between institutional investors—often referred to as "smart money"—and retail investors. When large institutions begin buying, OBV rises even if prices are flat; eventually, prices tend to follow the volume.
*   Cumulative Volume Calculation: The OBV is calculated by adding the volume to the previous OBV if a stock's closing price is higher than the previous day, subtracting the volume if it's lower, and keeping it unchanged if the price is identical.
*   Limitations and Considerations: As a leading indicator, OBV can produce false signals and may require confirmation from lagging indicators. Sudden volume spikes, due to events like earnings reports, can distort OBV readings.
*   OBV vs. Other Indicators: While OBV focuses on volume relative to the direction of price changes, other indicators like Volume-Price Trend (VPT) factor in the magnitude of price changes, offering different insights into market dynamics. 

![Image](https://www.investopedia.com/thmb/37PBfNDIw-Hd8dLZ62nw_x4I22Q=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/dotdash_INV-final--On-Balance-Volume-OBV-Definition-June-2021-01-16906b2a337a4e59a30a0b7d04a78a8a.jpg)

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## Understanding the On-Balance Volume (OBV) Formula

  

$\begin{aligned} &\text{OBV} = \text{OBV}_{prev} + \begin{cases} \text{volume,} & \text{if close} > \text{close}_{prev} \\ \text{0,} & \text{if close} = \text{close}_{prev} \\ -\text{volume,} & \text{if close} < \text{close}_{prev} \\ \end{cases} \\ &\textbf{where:} \\ &\text{OBV} = \text{Current on-balance volume level} \\ &\text{OBV}_{prev} = \text{Previous on-balance volume level} \\ &\text{volume} = \text{Latest trading volume amount} \\ \end{aligned}$

## How to Calculate On-Balance Volume Effectively

On-balance volume provides a running total of an asset's trading volume and indicates whether this volume is flowing in or out of a given security or currency pair. The OBV is a cumulative total of volume (positive and negative). There are three rules implemented when calculating the OBV. They are:

1\. If today's closing price is higher than yesterday's closing price, then: Current OBV = Previous OBV + today's volume

2\. If today's closing price is lower than yesterday's closing price, then: Current OBV = Previous OBV - today's volume

3\. If today's closing price equals yesterday's closing price, then: Current OBV = Previous OBV

## Insights Provided by On-Balance Volume (OBV)

The theory behind OBV is based on the distinction between [smart money](https://www.investopedia.com/terms/s/smart-money.asp)—namely, institutional investors—and less sophisticated retail investors. As mutual funds and pension funds begin to buy into an issue that retail investors are selling, volume may increase even as the price remains relatively level. Eventually, volume drives the price upward. At that point, larger investors begin to sell, and smaller investors begin buying.

Although plotted on a [price chart](https://www.investopedia.com/terms/d/dailychart.asp), the specific numerical value of OBV isn't important. The indicator itself is cumulative, while the time interval remains fixed by a dedicated starting point, meaning the real number value of OBV arbitrarily depends on the start date. Instead, traders focus on OBV movements over time; the slope of the OBV line is crucial for analysis.

 Analysts use OBV volumes to track large, [institutional investors](https://www.investopedia.com/articles/stocks/05/042605.asp). They view divergences between volume and price as a sign of how "smart money" interacts with regular investors, hoping to spot opportunities against prevailing trends. For example, institutional money may drive up the price of an asset, then sell after other investors jump on the bandwagon.

## Practical Application: Using OBV in Trading

Below is a list of 10 days' worth of a hypothetical stock's closing price and volume:

1.  Day one: closing price equals $10, volume equals 25,200 shares
2.  Day two: closing price equals $10.15, volume equals 30,000 shares
3.  Day three: closing price equals $10.17, volume equals 25,600 shares
4.  Day four: closing price equals $10.13, volume equals 32,000 shares
5.  Day five: closing price equals $10.11, volume equals 23,000 shares
6.  Day six: closing price equals $10.15, volume equals 40,000 shares
7.  Day seven: closing price equals $10.20, volume equals 36,000 shares
8.  Day eight: closing price equals $10.20, volume equals 20,500 shares
9.  Day nine: closing price equals $10.22, volume equals 23,000 shares
10.  Day 10: closing price equals $10.21, volume equals 27,500 shares

As can be seen, days two, three, six, seven and nine are up days, so these trading volumes are added to the OBV. Days four, five and 10 are down days, so these trading volumes are subtracted from the OBV. On day eight, no changes are made to the OBV since the closing price did not change. Given the days, the OBV for each of the 10 days is:

1.  Day one OBV = 0
2.  Day two OBV = 0 + 30,000 = 30,000
3.  Day three OBV = 30,000 + 25,600 = 55,600
4.  Day four OBV = 55,600 - 32,000 = 23,600
5.  Day five OBV = 23,600 - 23,000 = 600
6.  Day six OBV = 600 + 40,000 = 40,600
7.  Day seven OBV = 40,600 + 36,000 = 76,600
8.  Day eight OBV = 76,600
9.  Day nine OBV = 76,600 + 23,000 = 99,600
10.  Day 10 OBV = 99,600 - 27,500 = 72,100

## Comparing OBV and Accumulation/Distribution Indicators

On-balance volume and the [accumulation/distribution line](https://www.investopedia.com/terms/a/accumulationdistribution.asp) are similar in that they are both momentum indicators that use volume to predict the movement of “smart money”. However, this is their only similarity. In the case of on-balance volume, it is calculated by summing the volume on an up-day and subtracting the volume on a down-day.

The formula used to create the accumulation/distribution (Acc/Dist) line is quite different than the OBV shown above. The formula for the Acc/Dist, without getting too complicated, is that it uses the position of the current price relative to its recent trading range and multiplies it by that period's volume.

## Challenges and Limitations of Using On-Balance Volume

One limitation of OBV is that it is a leading indicator, meaning that it may produce predictions, but there is little it can say about what has actually happened in terms of the signals it produces. Because of this, it is prone to produce false signals. It can therefore be balanced by lagging indicators. Add a moving average line to the OBV to look for OBV line breakouts; you can confirm a breakout in the price if the OBV indicator makes a concurrent breakout.

Another note of caution in using the OBV is that a large spike in volume on a single day can throw off the indicator for quite a while. For instance, a surprise earnings announcement, being added or removed from an index, or massive institutional block trades can cause the indicator to spike or plummet, but the spike in volume may not be indicative of a trend.

## What Is Average Daily Trading Volume?

Average daily trading volume (ADTV) is the average amount of shares traded each day for a given stock. It can be a useful metric because high or low trading volume attracts different types of traders. Traders and investors can use ADTV to assess liquidity, analyze volatility, optimize trade execution, and manage risk. ADTV can be used alongside OBV and other indicators to evaluate the market's activity.

## What's the Difference Between On-Balance Volume and Volume-Price Trend?

Volume-Price Trend (VPT) is similar to on-balance volume in that it measures the cumulative volume and provides traders with information about a security’s money flow. But whereas OBV looks at volume just according to whether the close was higher or lower, VPT looks at _how much_ higher or lower it was. This helps determine a security’s price direction and strength of price change.

## Is On-Balance Volume Leading or Lagging?

On-Balance Volume is a leading indicator: it produces predictions, but it doesn't provide specific information on exactly what happened or why. This can lead to wrong interpretations. OBV should be used alongside lagging indicators for better effectiveness.

  

## The Bottom Line

On-balance volume (OBV) is a technical indicator that measures positive and negative volume flow and analyzes the trading direction. It appears as a single line that helps investors make trading decisions and identify buy or sell points. However, OBV doesn't provide specific information about the financial asset, which can lead to misinterpretations. Therefore, traders should balance OBV by using lagging indicators.

> **Article Sources**
>
> 1.  Joseph E. Granville. "Granville’s New Key to Stock Market Profits." Papamoa Press, 2018.