Volume indicators provide a very different kind of indicator because, instead of relying solely on the price, they take volume into account.
Prices tell you in which direction an investment is moving, but volume can tell you what kind of support is influencing the price. For instance, if you see a price rise accompanied by high volume, then you know that there are a lot of traders who have confidence in this investment. Seeing this support may give you confidence too. On the other hand, if you see the price of a share of CFD rise on low volume, you know that there are only a few investors pushing the price. This may discourage you from buying yourself.
There are two volume indicators that you ought to know about:
Developed by Joe Granville, on balance volume is a volume indicator that demonstrates positive and negative volume flow. It can also show you when price movement is not reflected in increasing volume, which usually results in a trend reversal.
On-balance-volume is usually plotted below the price movement on a chart.
There are four aspects of on balance volume which you ought to know about:
- How on balance volume is constructed
- On balance volume confirmations
- Strengths of on balance volume
- Weaknesses of on balance volume
How On balance volume is constructed
- On balance volume involves a calculation that utilizes today’s volume and the previous trading day’s on-balance-volume level.
- If today’s closing price is higher than yesterday’s, you add today’s volume to yesterday’s on balance volume level. You then record the resultant value below the price chart.
- Alternatively, if today’s closing price is lower than yesterday’s, you subtract today’s volume from yesterday’s on balance volume level. You then record the resultant value below the price chart.
- Connecting each on balance volume value gives you a smooth line that illustrates how volume has, or has not, supported the price movement of the share.
On balance volume Confirmations
Traders need to know whether a trend will sustain its momentum. On balance volume can help you decide if there is enough momentum behind a price to sustain it or continue pushing it higher.
Positive confirmation– on balance volume can provide positive confirmations of both upward and downward trends. If the on balance volume line is in an upward trend while the price is likewise rising, you know there is strong buying support. If the on balance volume line is in a downward trend whilst the price is also falling, you know there is strong selling support.
Negative confirmation– on balance volume can provide negative confirmations of both upward and downward trends. If the on balance volume line is in a downward trend while the price is in an upward trend, you know there is only weak buying support underpinning the upward trend. If the on balance volume line is in an upward trend whilst the price is in a downward trend, you know there is weak selling support underpinning the downward trend.
Strengths of on balance volume
- It does not rely on price alone in its calculation
- It helps you to confirm the strength of current trends
Weaknesses of on balance volume
- It lags behind the market since the data used to calculate on balance volume is historic and will not necessarily reflect what will happen in the future.
- It can give misleading indications of trends.