Core Philosophy and Calculation Mechanism of OBV
The On-Balance Volume (OBV), developed by Joseph Granville, is one of the earliest and most significant volume-price relationship indicators in technical analysis. Unlike indicators such as MACD or KDJ, which are constructed purely from price data, the core idea behind OBV is that "volume precedes price." It combines volume with the direction of price changes, using a single cumulative line to depict the ebb and flow of buying and selling pressure in the market. It aims to reveal the dynamics of capital inflow and outflow that are hidden behind price fluctuations and not easily perceived. OBV does not focus on the absolute level of prices but rather on tracking the process of capital accumulation or distribution, and is regarded as a powerful tool for gaining insight into the movements of "smart money."
The calculation logic of OBV is extremely simple and intuitive; it is a cumulative sum. The rules are as follows: if today's closing price is higher than yesterday's, all of today's volume is considered buying pressure, counted as a positive value, and added to the previous day's OBV. If today's closing price is lower than yesterday's, all of today's volume is considered selling pressure, counted as a negative value, and subtracted from the previous day's OBV. If the closing price remains unchanged, the OBV value does not change. The brilliance of this design is that it gives "directionality" to the raw data of volume, thereby constructing a continuous map of capital flow. It must be emphasized that the absolute numerical value of the OBV line has no practical meaning; its analytical value lies entirely in its trend direction and pattern changes.
Trend Confirmation, Divergence Signals, and Limitations
The most basic application of OBV is trend confirmation. A healthy, sustainable trend must be supported by concurrent volume. When the price chart shows an uptrend and continues to make new highs, the OBV line should also rise in sync and make new highs. This constitutes the ideal state of "price-volume harmony," indicating that buying pressure (volume) is actively pushing prices up and the trend is well-supported. Conversely, in a downtrend, as prices continually make new lows, the OBV line should follow suit and trend downward, showing that selling pressure dominates the market. If the price rises while the OBV line moves sideways or falls, it forms the beginning of a price-volume divergence, suggesting insufficient upward momentum.
However, the most predictive application of the OBV indicator lies less in trend confirmation and more in its capture of "divergence," which makes it a powerful leading indicator. OBV divergence is considered one of the most reliable reversal signals in the market. When the price chart is still making new highs, continuing its superficial strength, but the OBV line below fails to make a new high, instead moving flat or even forming a lower high, a "bearish divergence" is formed. This clearly reveals that although the price is still being pushed up, volume (i.e., smart money) is no longer following, and may even be secretly distributing shares. This is a strong warning signal, indicating that upward momentum is about to be exhausted and the risk of a top reversal is extremely high.
The opposite "/bullish divergence" is even more valuable. When the price is making new lows in a downtrend, causing market panic, but the OBV line refuses to continue lower, instead stabilizing first and forming a higher low, a bullish divergence is constituted. The meaning of this signal is: although the price is still falling, the volume on the sell-side is shrinking, and at the same time, "prescient" capital (smart money) may be taking advantage of the panic to quietly accumulate shares at low prices. This suggests that the downward momentum is at its end, and a significant market bottom may be forming.
Although OBV is excellent at providing insight into capital flow, its inherent limitations cannot be ignored. First, its calculation method is overly simplistic and crude, attributing all of a day's volume based solely on whether the close was up or down, which ignores complex intraday dynamics. Second, OBV is extremely susceptible to distortion from single-day extreme volume spikes. For example, a massive volume day caused by breaking news or an earnings release can instantly and dramatically change the OBV value, causing the indicator to become "distorted" and difficult to read for a long time afterward. Therefore, rational analysts typically do not use OBV in isolation. Instead, they use it as an "X-ray" to verify the health of a price trend, combining it with other indicators like Moving Averages (MA) or KDJ to build a more multi-dimensional perspective of the market.
