Volume by Stuart Evens
What do technicians look at in order to qualify the significance
of a trend? One key element is volume, in that high
volume in a trend indicates that large players may be involved.
The theory goes that large traders are better informed,
so the trend is likely to continue. How can you track
volume? Does a volume-based indicator help the analyst and
trader? Take a look.
One of the better-known technical
indicators to track volume
is the on-balance volume
(OBV). The OBV line is simply
a running sum calculated by
adding or subtracting the
security’s daily volume from
the previous day’s OBV value,
depending on whether the
security‘s closing price was up
or down for the day. The OBV
line is usually plotted as a line above or below the price bar
graph of the security (Figure 1). Two popular uses of this
indicator is to watch for confirmation of the price trend by the
OBV line, indicating that the volume is increasing in the
direction of the trend, and forewarning of a trend reversal by
the divergence between the direction of the OBV line and the
price trend. Let’s look at the initial method and theory.
OBV creator Joseph Granville first presented the concept of
OBV in Granville’s New Key To Stock Market Profits. In
developing this tool, Granville started with the premise that
market participants are divided into smart money entities and
the general public. He assumed that the smart money was able
to accumulate stock at lower prices compared with that of the
public based on their having better information.
During a bull market, Granville theorized, smart money
initially bids prices up and then only participates in the
buying for the first-half to two-thirds of the move. At that
point, smart money players are fully invested and are now
holding for the last third of the move, planning to sell out at
the top. He opined that this is just when most of the public is
starting to notice the runup in prices and is buying the stock.
This sets the stage for the smart money, who then dumps
stock to the public.