Ok, we are back!  We have been going over a number of different indicators to see if they can assist with our trading.  We have picked a few of the more popular indicators.  Those being the MACD, RSI, Bollinger Bands and this week we are going to peruse the OBV, or commonly known as the on-balance volume indicator.  We talked about the MACD and RSI and how they were able to give us buy and sell signals and that more importantly, they could show us divergence which we could use to see a possible shift in the direction of a particular equity.  Using these tools in the proper context, with price and time, can assist with our determinations of where things might be headed.  Last week we deviated from the divergent type indicators and we looked at the Bollinger Bands.  These bands work off of the concept of volatility and use standard deviations in price to determine when an equity may be overbought or oversold.  The Bollinger Bands, as expressed by the creator of the tool, are not stand alone tools and need to be used in conjunction with other good technical analysis techniques to determine when an equity might be out of its standard trading range.  As I stated last week, John Bollinger, had 22 rules that he used in conjunction with his bands to ensure that he was trading them properly.  The one last thing that one must remember about the Bollinger Bands indicator is that even if something moves one standard deviation doesn’t mean that it can’t move two or even three standard deviations in price although the odds of that happening decrease greatly as you move out in deviation count.  We could see that in the bell-shaped curve chart, that as we moved further out in the number of deviations the percentage chance dropped significantly.

This weeks indicator is the on-balance volume indicator.  In this blog, we have previously discussed volume and how we use it to either confirm our suspicions about price action or to help us understand the psychology of the market participants.  We talked about how increasing volume can show us the strength of a trend and we have also shown how decreasing volume can mean that change could be on deck.  We have talked about how really big volume can mean that certain market participants are desensitized to price and that it can sometimes mean that a reversal could be in the works.  We have also talked about how markets on lower volume or decreased participation tend to float in an upwards direction and that volume tends to increase when reversals happen.  Volume is one of the most important tools one can use in addition to price and time.

This brings us to the on-balance volume indicator.  OBV is a momentum indicator just like the MACD or the RSI.  It was developed behind the theory that if one could distinguish when the big money players were getting in or out of a position that one could reasonably expect that a change in direction could be taking place or might be taking place in the near future.  On-balance volume is a running total of volume.  It uses the closing price of the day and the previous OBV to come up with the next OBV point.  If the closing price is higher than the closing price of the previous day then the volume of that day is added to the previous day OBV and if the opposite is true, the closing price is lower than the previous day then the volume is subtracted from the previous day’s OBV and these points are plotted along a line and shows the trend of volume.  Take a look at an example below to see how the OBV is plotted.

So how do we use the OBV to our advantage?  We use it in a similar manner to that of other momentum indicators.  Much like our MACD and RSI indicators, we are looking for divergence.  Divergence meaning when the price pivots of the stock are going in the opposite direction of the OBV pivots then this can signal that a change could be in the works.  Take a look at the chart of FB below and look at the yellow lines that I have drawn and you will see the divergence that I am referring to and then you can see what happens to the price of FB shortly after the divergence.  As always I must caution that no indicator is 100 percent foolproof and therefore we need to act accordingly.

You can see from the yellow lines that price pivots are rising and the OBV pivots are falling.  This is classic divergence and you can also see that after the divergence there was a change in direction.  If you look at the whole chart you can see that most of the time the OBV follows that trend of the prices but at times they are different and these are the times that we need to pay attention to.  We would not act solely on this information but we could use this and the price actually turning to create a higher probability setup for a trade.

After going through a number of indicators you can see that they all have strengths and weaknesses and as long as they are used in conjunction with good technical analysis chart reading that they can be helpful.  Most people won’t be able to or want to use all the indicators that we have gone over but you may find a couple of your favorites and throw them on your charts to help in you trade setup.

Although there are a tonne more indicators, we have covered a few of the more popular ones and you can always research others if you are interested in learning more and a great place to start is this website. Check out other articles and videos on Tackletrading.com to get more in-depth with the world of indicators.

In next weeks blog, we are going to start looking at what things we need to determine before entering a trade.  Things like market bias, entry and exit points and target areas.  Until next week throw OBV on your charts and see if it works for you.