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When Indicators 'Lead' Price

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When I was a young sprout on the Street of Dreams, my trading mentor used to say quite often that 'volume precedes price'. Meaning that when a stock or index has reached an area of buying or selling interest, especially for professional traders and money managers, there is usually at least some pick up in volume (buying or selling) before an actual trend shift or turn up or down that's seen with a final top or low; or by a trendline(s) being pierced.

When a stock is under accumulation (being 'accumulated'/bought) or distribution (being sold/'distributed'), acute observation of volume trends can alert savvy market observers BEFORE an actual trend reversal or an acceleration of the trend. This 'heads up' may only be a day or two, but if a trend has been down, down, down, those interested in finding the inevitable bottom, at least in the case of a quality company, will be alert to the stirrings of buying interest. The same is true of a top; even the best companies will see their stock get overvalued and some institution will start to unload a few blocks of it, before there's any appreciable change in trend.

ON BALANCE VOLUME:
The normal way of displaying volume is by selecting "Volume" as an Indicator on charting applications - volume is displayed as a histogram or as vertical bars that show the volume total for that day on the right hand numerical volume scale.

On Balance Volume or OBV is also a type of volume indicator or volume-related technical formula; i.e., a mathematical calculation that is calculated and graphed with a financial instruments price and/or volume information.

OBV is an indicator that constructs a running total of volume that ADDS all the day's volume number when the close is higher than the day before and deducts ALL the day's volume when the close is lower than the prior trading session.

OBV CONSTRUCTION:
Assume that we start with a stock that traded a million shares on day 1 and assume this day is our starting point; we have to start somewhere. If the stock closes higher the next day and trades 750,000 shares, day 2s volume figure is added to the first day and assigned a positive number because our running total is a positive number; OBV is now a +1,750,000.

[NOTE: OBV would be a negative number if our example stock closed lower on day 2, on 1,500,000 shares: OBV would be 500,000.]

Going back to the example. Assume that on day 3 the stock closed lower on 500,000 shares and that days volume is subtracted from the cumulative OBV total: day 3, OBV equals +1,250,000. The stock is unchanged in price on day 4 and OBV is also then unchanged and remains +1,250,000.

This calculation process continues on into the future. If we graph the points, the resulting line will start moving upward or downward following the direction of the price trend of the stock for which OBV is being calculated.

Using the OBV Indicator with daily volume BARS:
I often display the OBV indicator on TOP of the daily volume bars per the GE chart below. If your own charting application or one on a web site only allows OBV use as a separate study, you can put it above or below the volume indicator:

General Electric (GE) had an interesting pattern of lower relative highs and higher lows, making a symmetrical triangle formation, as outlined below on its daily chart; a pattern that suggests that buying and selling forces are more or less in balance. A break out above or below this kind of triangle pattern usually suggests a strong move in the direction of the breakout. TRENDLINES applied to the On Balance Volume (OBV) line show the same up and down direction swings as price.

The OBV line in GE started up in early-September as seen above and the OBV line was quite consistently trending higher, even as the stock had an initial price dip back to the prior low. OBV here was showing the beginning of accumulation of the stock and helping reinforce a buying decision such as in calls or selling puts.

When the OBV downtrend line shown on the OBV graph above was pierced to the upside early in December, this was just ahead of the bounce and rally off the GE up trendline on the price chart. It was certainly reinforcing for what price action was doing. The recent pullback in prices has accompanied an OBV line that is trending higher, suggesting that the recent consolidation in bellwether GE will lead to another surge higher. This prospect also bodes well for a continued move higher in the S&P indices.

Certainly, SPX held 1410 and OEX above 655, the key supports suggested in my weekend Index Trader column, which can be seen online by clicking here.

OBV DIRECTION IS THE KEY:
With the OBV indicator, we are not concerned about whether volume is greater than or less than another day, and are looking at the direction of the LINE; i.e., it the OBV line trending higher with an up trend or lower with a down trend (volume is 'confirming' the price trend)?

Conversely is the OBV line trending down while prices continue higher; or, lower while prices trend higher; i.e., volume is 'diverging' from the price trend and suggests that the trend may be technically weak.

If the direction is up, the OBV line is bullish, as there is more volume on up days than on days when the stock price is down. A falling on-balance volume line is bearish, as more stock is being traded on down days than on up days. If both price and OBV are moving up together, it is a bullish sign portending higher prices. If both price and OBV are moving down together, this is a bearish indication for still lower prices ahead.

If prices move higher during a period of time when OBV lags or moves lower, this is a bearish divergence indicating diminishing buying activity and warns of a possible top or trend reversal. Conversely, of course, if prices are moving lower but OBV is trending higher, this is bullish divergence. This is not unlike other divergences such as when prices are trending lower, but with rising RSI lows; and, vice versa for a bearish divergence ith prices moving higher without a corresponding new high in the RSI oscillator.

BLAH, BLAH, BLAH
Enough with the words, on with the charts with On Balance Volume (OBV) markings on some key or bellwether stock charts relative to the S&P and Nasdaq indexes:

Intel Corp. (INTC) is of course a bellwether for the key semiconductor index, which is turn is a bellwether sector index in terms of the Nasdaq's prospects. INTC made an approximate double bottom low in the May to July period. However, traders didn't have to wait necessarily for that confirming sign of a bottom if they were also watching the OBV trend.

In terms of what a trendline highlighted with the OBV line above, OBV was trending higher AHEAD of the July double bottom intraday low in INTC. This is good example of volume trends, preceding price trends.

Google (GOOG) sure has been an interesting company, with its dynamic search engine and business model. The stock has been a great 'trading' stock also. On Balance Volume has shown some useful patterns that has reinforced clues to bullish or bearish price action; sometimes OBV has been slightly 'clearer' or ahead of the clues provided by the chart patterns.

Like a commodity chart (or a high-beta stock!), GOOG had some fast-paced bull flag formations over the course of its strong bull move of the fall. Trends in the OBV were insightful also.

The OBV trend was up clearly in GOOG, during the sideways move of the 1st. bull 'flag' pattern outlined above, suggesting reinforcement to the idea that strong accumulation of the stock was going on for a continued move higher. The 'breakout' noted at the OBV line above reinforced the idea of a bullish surge after bull flag #2 formed. The 'breakdown' suggested by the OBV trendline was a tip off for price weakness ahead earlier this month.

Microsoft (MSFT) has been a very consistent performer in the strong bull move in the market since this past summer. The sideways price consolidation (bull flag) of August highlighted on the MSFT daily chart below was accompanied by an OBV line that was consistently trending higher; if you didn't spot the bull flag pattern (a strong upswing followed by a sideways move; or, minor pullback dip as in GOOG above) but were watching the OBV line trending higher, it was apparent that the stock was being accumulated.


LOVE THOSE I-PODS, UNTIL WE DON'T
Apple Computer (AAPL), the maker of the trust MAC, which many California friends swear by, but which I never quite know how to use relative to my PC, has had a terrific run up fueled by the success of the new ubiquitous I-POD accessory in the X or pre-X generation.

I loved the stock until the recent breakdown and pullback; which may have ended today. I exited some calls on the stock when AAPL not only gave some signs of 'churning' and sideways wide-ranging intraday price swings indicative of a top, but when my OBV trendline got pierced as seen below.

The aforementioned OBV trendline 'break' (the line fell under its up trendline) with the close of 11/29, whereas the stock didn't start breaking below the low end of its price range until 12/6. An early Holiday present was had by profit-takers in AAPL calls bought a few weeks prior who exited based on the OBV trend action.

Again, because OBV is a directional line, it's easier to see the direction of the volume trend, in order to match it to the price trend. It is not the holy grail of indicators, but On Balance Volume is useful, especially at those times when daily volume jumps around; you need only glance at OBV to confirm the dominant trend in trading activity. It's even more useful when OBV turns up or down ahead of key (price) reversals.

GOOD TRADING SUCCESS!

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