The document discusses the On-Balance Volume (OBV) indicator, which measures a security's momentum by incorporating volume into the basic price graph. When prices close higher, volume is added to the OBV total, and when prices close lower, volume is subtracted. Divergences between the OBV line and price movements can signal potential trend reversals. The document analyzes the OBV for the Dow Jones Industrial Average in 1998, identifying divergences in April-May and June-July that correctly predicted coming declines in the Dow after it had reached new highs.

1. Bloomberg May 1999 87
EQUITY
M
ost technical indica-
tors are built around
price movements. The
On-Balance Volume In-
dicator function, OBV, is a bit dif-
ferent. It’s based on both price and
volume moves—a relationship that
gives important insights about a mar-
ket’s momentum as well as its direction.
Although prices represent a con-
sensus of value, volume represents a
consensus of the financial and emo-
tional commitment of market partic-
ipants. Each trading day in any given
market there’s a kind of battle over
value between bulls and bears, with
the level of intensity of the conflict
revealed through the day’s volume.
OBV measures a security’s momen-
tum by adding a volume component
to the basic price graph. When prices
close higher, bulls have won the trad-
ing day and volume for the day is
added to OBV. When prices close
lower, bears have won the trading day
and volume for that day is subtracted
from OBV. If prices close unchanged,
OBV stays unchanged. OBV is thus
a running tally of volume.
How might an analyst read an OBV
signal? “I use OBV for its direction,
not absolute level. OBV and prices
usually move in the same direction.
I also use it for divergences,” says
Fabrice Todeschini, derivatives trad-
er at KBC Bank Luxembourg.
In bear markets, cumulative OBV
readings can turn negative. Because
volumes have different characteristics
and relative levels in stock and fu-
tures markets, the absolute level of
OBV is secondary. What really mat-
ters are the shape of the OBV line
and its relationship with prices.
You can see how the relationship
plays out. The graph in figure 1—ac-
cessed by typing INDU <Index> OBV
D <Go> and entering the one-year
date range 12/31/97–12/31/98—
compares Dow Jones Industrial Aver-
age price activity with OBV activity for
that period. You’ll see that from early
January until early April, prices and
OBV moved in the same direction,
thereby confirming the uptrend.
Now notice the behavior of prices
and OBV from the rest of April
through the end of July. More pre-
cisely, look closely at the triple tops
on OBV in April—a period during
which prices were reaching new
highs. A pattern of three successive
tops in a price or OBV line is techni-
cally significant because triple tops
often are considered signals of an im-
pending reversal in the most recent
trend. “Triple tops or triple bottoms
are significant because they show a
cap or floor on price action. They sig-
nal possibilities of a trading range,
then the exit of the range in the di-
rection of the trend or as a reversal.
TrackingExuberance
inaRationalMannerKnowing whether
bulls or bears are at
the helm in any given
market situation
might not be enough;
you also may need
to know how hard
the beasts
are running
By Jean-Marc Bloch
FIGURE 1. Type INDU <Index> OBV D <Go>. Tab down and adjust the date
range fields to graph on-balance volume for the Dow Jones Industrial Average
index for 1998

2. 88 May 1999 Bloomberg
In technical analysis, there have
never been four tops or bottoms in
prices. Volumes through OBV pat-
terns reflect these outcomes,” says
Michele Contarini, investment spe-
cialist and technical analyst at Ameri-
can Express Bank in Luxembourg.
That view was borne out, as shown
by the ensuing steep decline in the
OBV line.
During early May, in this example,
prices rallied strongly and the OBV
line resumed its upward move, but
OBV’s successive highs in early May
failed to break the previous highs
established in April. This was a very
strong market indication that prices
were fixed in a range.
The Dow actually reached new
record highs in May but on a much
lower level of OBV than those in
April. This was a yellow warning light.
And when a yellow light appears,
a red one usually isn’t far behind.
When the pattern of OBV diverges
from the pattern of prices, it indicates
that market financial commitments
are not in line with market
consensus on prices.
The best example on
this graph that a diver-
gence of OBV and price
signals a major market
turn can be seen later in
June and into July. The
Dow rallied then while OBV re-
mained roughly at the same level—
and at lower levels than in the April-
May period. This was both a second
strong deviation and a second warn-
ing signal from the market.
In studying this example and other
examples involving OBV, keep in
mind that the pattern of OBV tops
and bottoms is of primary impor-
tance and that absolute levels of OBV
are of secondary importance. When
OBV rises or falls together with
prices, a trend is confirmed and it’s
safer to trade in this direction. When
OBV reaches new highs, it confirms
the power of bulls and indicates that
prices might go even higher. When
OBV reaches new lows, it confirms
the power of bears, and it hints at
lower prices.
The strongest signal is given when
OBV and prices diverge. Obviously,
the longer the time frame, the
stronger the pattern and the larger
the magnitude of the ensuing move
might be.
In our example with the Dow, we
can define this type of divergence in
two sequences, each of which con-
tains two phases.
Sequence 1: April-May
• April triple tops on OBV.
• April-May shows divergence
between prices and OBV.
• Prices are ranging at about 9,000
levels—plus or minus 270 points.
• OBV fails to breaks new highs.
Sequence 2: June-July
• June prices rally on sideways
pattern of OBV; July’s decline is
confirmed by OBV’s direction.
• Prices are rising above 9,000
points, reaching new record high
above 9,300.
• OBV is lower than in April.
This decomposition exercise vali-
dates the probability of a reversal pat-
tern on the Dow. Another analysis
of that August divergence is worth
having a close look at in this regard
as well.
Figure 2—accessed by typing INDU
<Index> OBV <Go> and using date
range 07/01/98–12/31/98—shows
the bullish divergence in Septem-
ber/August through early October
followed by another spectacular re-
versal. The divergence came on Oc-
tober 8, when the index fell below its
September 10 low but OBV didn’t
follow, signaling that the low wasn’t
being made on heavy volume. You
can easily see symptoms of rational
exuberance’s getting its comeup-
pance in this pattern, and you can
draw the appropriate lessons for your
own trading. Knowing when money is
moving in and out of a market gives
you a better understanding of your
investing risk; it hints at when to take
profits; and it helps you spot poten-
tial losses before they occur.
¬Any comments? Type MAGAZINE
<Msge>.Forreprints,typeMAGZ <Go>.
Jean-Marc Bloch is on the staff of the
Bloomberg Sales department in LondonFIGURE 2. Type INDU <Index> OBV <Go>. Tab down and adjust the date range
to display OBV levels for the second half of 1998
¬To establish or reset any of the default
parameters for technical indicators on the
Bloomberg service, type TDEF <Go>.
Type TDEF <Help> for more
information on the function
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