Alternatives On Balance Volume (OBV)

The on balance volume line does its job reasonably well, but it has some shortcomings. For one thing, it assigns an entire day's volume a plus or minus value. Suppose a market closes up on the day by some minimal amount such as one or two tics. Is it reasonable to assign all of that day's activity a positive value? Or consider a situation where the market spends most of the day on the upside, but then closes slightly lower. Should all of that day's volume be given a negative value? To resolve these questions, technicians have experimented with many variations of OBV in an attempt to discover the true upside and downside volume.

One variation is to give greater weight to those days where the trend is the strongest. On an up day, for example, the volume is multiplied by the amount of the price gain. This technique still assigns positive and negative values, but gives greater weight to those days with greater price movement and reduces the impact of those days where the actual price change is minimal.

There are more sophisticated formulas that blend volume (and open interest) with price action. James Sibbet's Demand Index, for example, combines price and volume into a leading market indicator. The Herrick Payoff Index uses open interest to measure money flow.

It should be noted that volume reporting in the stock market is much more useful than in the futures markets. Stock trading volume is reported immediately, while it is reported a day late for futures. Levels of upside and downside volume are also available for stocks, but not in futures. The availability of volume data for stocks on each price change during the day has facilitated an even more advanced indicator called Money Flow, developed by Laszlo Birinyi, Jr. This real-time version of OBV tracks the level of volume on each price change in order to determine if money is flowing into or out of a stock. This sophisticated calculation, however, requires a lot of computer power and isn't readily available to most traders.

These more sophisticated variations of OBV have basically the same intent to determine whether the heavier volume is taking place on the upside (bullish) or the downside (bearish). Even with its simplicity, the OBV line still does a pretty good job of tracking the volume flow in a market-either in futures or stocks. And OBV is readily available on most charting software. Most charting packages even allow you to plot the OBV line right over the price data for even easier comparison.