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This Week's Guidepost

1. Last week we reviewed the value of volume, the number of shares traded during a session, in trying to understand where the market is taking the price of our stock. Some general rules we can identify, based on last week’s discussion include:
   • A price pattern that is rising with increasing volume is considered bullish.
   • A price pattern rising on decreasing volume is bearish. Watch for a weak rally.
   • A price pattern decreasing on rising volume is bearish and a bad-news flag.
   • Falling prices with increasing volume is often a bullish indicator.

2. There are of course exceptions to each of these rules but they are generally sound. We will discuss some of the exceptions in future Guideposts. In this Guidepost we will discuss an easier way to track volume and the messages sent by examining the On-Balance-Volume indicator.
3. The On-Balance Volume (OBV) indicator shows graphically the flow of volume in a stock. This line is a running accumulation of the daily volume numbers, adding volume on days the price goes up and subtracting on down-days. A price and volume chart for one of our picks is shown below with the resulting OBV drawn in between.
OBV Resulting from Price/Volume Pattern (ANSR)
4. In this chart we notice several things:
   • The yellow OBV line follows the volume bars in bottom frame, although this is not easy to see. During the month of September, the price is declining as is the height of the volume bars after the first week. Since the price is declining, each day’s volume is subtracted from the OBV total. That is why the slope of the OBV line is decreasing during this time. Moving into October, the price begins to increase, so we add the daily volume to the OBV total. This causes the line to increase as shown.
   • The OBV line seems to track the price chart. This is the normal case. When we see the price and OBV lines in parallel, we say things are as they should be. Nothing is broke!
   • It is easier to tell what the volume is doing by looking at the OBV than reading the volume bar-chart at the bottom. We can make it even easier as shown in the next chart.

5. We plot the OBV over the price in the next chart to show how easy it is to compare volume changes to the price activity. About all this particular chart tells us is that the price follows volume, confirmation of our discussion on the supply/demand relationship. We will find the greatest benefit from these comparisons when volume does not confirm price action.
OBV Plotted over Price Pattern (ANSR)
Note: The importance of the OBV line is its trend, the direction the line is going, not how high the line is. Lets say that in another way: The highest point in the OBV line is not where volume is greatest, or where volume flow provides the greatest support to the price line. We must watch the direction or slope of the line!
6. The OBV technique tries to uncover hidden accumulation and distribution patterns before a price change happens. If a stock closes higher than the previous day, then the day's volume is considered positive (accumulated or demand) volume. When a stock closes lower, then the day's volume is negative (distributed or supply) volume. We are paying attention to what really drives price - the volume.
7. In the next chart we examine what looks like a bullish volume pattern during a time when the price is decreasing (May through November). The last thing we see the price doing is moving up a couple of dollars! The buying pressure (accumulation) was evident by the OBV and the price pattern finally caught up.
Bullish OBV with Daily Price Pattern Following (AETC)
8. In last week’s Guidepost we compared the daily price chart with the weekly to get another view of the pattern. The weekly view is a bit “out of the forest,” helping our big-picture view of the messages sent. Here is the weekly picture of the previous chart for comparison.
   Weekly Price Chart with OBV (AETC)

9. To reinforce the point made earlier about the importance of OBV direction and not magnitude, lets look at the following price chart of another pick. In this case we see a dramatic change in OBV about mid-December. The OBV tracks price fairly well in all of December with the exception of this one jump. We see from the volume bar that it was the result of a volume spike on just one day, but it didn’t change the basic character of the price pattern. Point: The OBV pattern after the jump is no more valid that the OBV pattern the first part of the month. They both follow the price (in direction, which is all that is important).
Daily Price Chart with OBV (QSND)
10. The basic premise of OBV analysis is that volume changes occur before price changes. This is because the strength of market action is reflected in volume first, not price. The theory is that "smart money" (institutions, funds, etc.) flows into a stock with a rising OBV before the stock price rises. When the rest of us then move into the stock, its price and the OBV will rise. Point: "Smart money" must deal with the general public for this all to work, since the smart money needs someone to buy from and sell to in order to make its profits. That someone is us.
11. It does not matter what makes smart money smart, or who the smart money investors are. All that's important is their money-moves ultimately determine the price. OBV is a method to reveal these moves. For a review of the OBV indicator, click on our Archives link on the home page and read carefully the Guidepost dated May 28, 1999.
12. On reflection, we must keep all the indicators we've studied in perspective. None of them are perfect. We will find great value in combining them, finding confirmation where together they strengthen the underlying messages. In this manner we will greatly enhance our chances for success. That's where we are going, stay tuned.

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