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Confirming It's Time to Buy Stocks using Momentum Indicantors
Developing a consistent set of indicators to use is a core skill every trader must develop to suit their trading style. One of the most simple indicator types to utilize are volume based momentum indicators. In this article you will learn how to implement On Balance Volume, as well as its strengths and weaknesses, and an updated indicator that is even more powerful than OBV called On Balance True Range
Implementing volume centric momentum indicators provides you several key benefits, none the least of which is simplicity of reading. Momentum indicators tend to be very simple to interpret, and can provide traders important insight into market trends,
On Balance Volume (OBV)
On balance volume is a momentum indicator that was created by Joe Granville in 1963. The on balance volume indicator is designed to measure positive volume flow. The key concept to understand is that volume preceeds price, and as such, measuring the flow of volume (into or out of a stock) provides traders a leading indicator on market trends.
On Balance Volume is constructed as a running total of volume flow. Volume is added to the total when price closes to the upside, and subtracted from the total when price closes to the downside. This is a key concept that the indicator is based on closing prices, I'll discuss why in a moment.
Traders use the OBV indicator to find divergences between volume and price.
The definition of divergence as supplied by StockCharts.com
A situation that occurs when two lines on a chart move in opposite directions vertically. People often look for divergences by comparing a stock's direction to the direction of its RSI, its MACD or its Stochastic Oscillator. There are two kinds of divergences: positive and negative. A positive divergence occurs when the indicator moves higher while the stock is declining. A negative divergence occurs when the indicator moves lower while the stock is rising.
With respect to On Balance Volume, a divergence indicates that volume is not supporting the current trend, and that momentum is fading. If a trader were looking to buy a stock, and saw a negative divergence in the On Balance Volume indicator, that trader would not want to buy that stock stock.
Strengths and Weaknesses of On Balance Volume
On Balance Volume's primary strengths are the simplicity of reading the indicator, and the ability to identify weakening trends. However, OBV does have a few weaknesses that traders need to be aware of:
The primary weakness of the OBV indicator is that it rquires a full day's price action to construct. Thus, it is not well suited to intra day trading.
The subsequent weakness of OBV revolves around gaps in price. Since no trading volume occurs in a price gap, OBV discounts this piece of price movement.
Tom Bierovic addressed these weaknesses when he created his own indicator: On Balance True Range.
On Balance True Range (OBTR)
Before I discuss the implementation of OBTR, it is important to understand that there is a significant statistical relationship between volume and the price movement of a stock. Statistical analysis of this relationship has been well documented, such as in this MIT Laboratory for Information and Decision Systems report: Relationship between Trading Volume and Security Prices and Returns.
True Range
The first component of the OBTR momentum indicator is called True Range. True Range. True Range, as defined by J. Welles Wilder is:
True Range (TR) which is defined as the greatest of the following:
The current High less the current Low. The absolute value of the current High less the previous Close. The absolute value of the current Low less the previous Close. If the current high-low range is large, chances are it will be used as the True Range. If the current high-low range is small, it is likely that one of the other two methods would be used to calculate the True Range. The last two possibilities usually arise when the previous close is greater than the current high (signaling a potential gap down or limit move) or the previous close is lower than the current low (signaling a potential gap up or limit move). To ensure positive numbers, absolute values were applied to differences.
As you can see, true range is a measure of price movement, and, as stated before, is highly related to volume. Mr. Bierovic simply replaced the Volume component of OBV with True Range, to create On Balance True Range.
OBTR addresses the two weaknesses in OBV. First, OBTR is always up to date, and second, gaps are handled properly in this indicator.
OBTR can be combined with a 9 day moving average (EMA) to create buy and sell signals. A bullish signal occurs when OBTR crosses above the EMA, and a bearish signal is generated when OBTR crosses below the EMA.
Combining OBTR with MACD
Combining OBTR with a dual MACD system can be a very powerful set of indicators for determining price entries (when to buy stock), and exits (when to sell stock).
A 12,26,9 MACD is combined with OBTR for buy signals. Look for bullish divergence between price and the OBTR, and bullish cross overs in both the MACD and OBTR for entry points.
A 19,39,9 MACD is combined with OBTR for sell signals. Wait for the MACD to display a bearish cross, or cross below the 0 line, and confirm this signal utilizing OBTR bearish divergence or crosses.
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Follow along live trades using On Balance True Range, and a triple indicator cross over system that consistently predicts quick 10% moves in stocks This system was developed as part of Steve Warshaw's new e-book, Ultra Profitable Stock Screens, which will be released in March , 2010. Click here to receive an email update when it has been released |
| Category: Articles | Added by: forex_s (2010-01-18)
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| Views: 286 | Comments: 1
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