One lesser-known indicator that can potentially be used to confirm trends and identify reversals is “on balance volume” or OBV, an indicator that leverages the idea that changes in volume often foreshadow changes in price. Let’s get right into the intricacies of the indicator.
If you’re looking for a confirmation in trend, look for the OBV to follow the overall price trend. When looking at this indicator for this purpose, focus primarily on the trends and changes in trend of the OBV, as well as price. On the other hand, if you’re for a change in trend — rather than a confirmation — you want to see the OBV and price trend in opposite directions. When this occurs, it can signal a reversal.
Now that we’ve got an idea of how to use this indicator, let’s take a look at an example.
OBV in the charts
Here’s a daily chart on the PowerShares QQQ Trust, Series 1 (QQQ).
If you look at the chart above, the 50-day simple moving average is plotted, and a support uptrend line is drawn. Below the price chart, you’ll notice the OBV indicator. Now, both the OBV and price were trending higher over this period, indicating a confirmation of trend, up until the OBV broke below its lower uptrend line.
Once the OBV broke below that support trend line, it was an indication that there was a bearish divergence, and there could be a reversal in trend.
Here’s what happened after the bearish divergence.
Notice how there was a reversal in trend in the OBV, and thereafter, the price broke below its 50-day simple moving average, and uptrend line.
The bottom line
Changes in volume often precede changes in price, and the OBV can be used to determine potential changes in price trends, as well as to confirm a trend. Do your homework, and practice looking for these trends/changes — keeping in mind that no indicator works 100 percent of the time — and you will add an effective piece to your toolkit for swing trades.
Keith Kern has been a full-time day-trader for 17 years; he moderates the Lightning Alerts chatroom at BiotechBreakouts.com.
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