How to use the On-Balance Volume indicator in cryptocurrency trading
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In a previous post, we have looked at using the volume indicator to identify strong trends and breakouts in your crypto trading. Here, we’ll talk about how to use the On-Balance Volume (OBV) indicator to spot periods of “smart money accumulation” and divergence.
The OBV indicator was introduced in the early 1960s in Joe Granville’s book titled Granville's New Key to Stock Market Profits, and works by calculating positive and negative volume flow and displaying the resulting data with a line.
Here’s a summary of the key ideas behind OBV.
- Closing price is above the previous close:
Current OBV = Previous OBV + Current Volume
- Closing price is below the previous close price:
Current OBV = Previous OBV - Current Volume
- Closing price equals the previous close price:
Current OBV = Previous OBV (no change)
Here’s an example chart showing OBV data for BTC.
This is what the OBV indicator looks like on a chart – just a line.
What does OBV tell us?
Similar to the RSI indicator, OBV can also reveal potential periods of “smart money” accumulation. The idea here is that volume often precedes price action. Since OBV is an indicator based on volume momentum, periods of OBV divergence against price may indicate “smart money” buying into retail investor sells, or vice versa.
This can be useful when margin trading, but also, when looking for general entry and exit points.
Once the retail side is exhausted, price often moves in the opposite direction, causing retail investors to FOMO back in.
You can think of this divergence model as a water dam filling up before opening up on the other side. When the dam is filling up, price stays flat while OBV moves in a divergent direction. After the dam is filled, the other side can open up causing a price reversal.
In the example below, you can see XRP/USD exhibiting bullish divergence – price makes a lower low while OBV makes a higher low. This suggests sellers are getting exhausted and are starting to sell into smart money. As a result, XRP reverses and moves 25% to the upside.
This example of ETH/USD shows a case of bearish divergence where price makes a higher high while OBV makes a lower high. In this situation, the bearish divergence was followed by a 12% move to the downside.
It’s also worth watching OBV support and resistance breaks. The image below shows ETH/USD in the same timeframe as the above example. The red line on the OBV chart indicates a clear support trendline.
As you can see, the break of this trendline coincides with the price top and precedes the large price drop. This would have been a good short or sell indicator, especially when confluence with other indicators can be observed.
In conclusion, the OBV indicator is a measure of volume momentum plotted as a line. It can be used to identify periods where price action does not match the asset’s volume profile. As a result, it can be used to identify situations where retail investors are unknowingly giving up their positions to “smart money”.