Greetings, fellow Pro-fundity team members -
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This week's Editorial Guidepost:

1. The indicators we've studied so far have dealt with prices, their averages and patterns. Graphically, this has helped us predict the direction a price-line may take. We also discussed in an earlier Guidepost the important role volume plays in the supply/demand relationship, setting support and resistance levels for a rolling stock. We saw how volume can be used with price to determine the strength of a trend. That is, if the price is rising with heavy volume, the rise is likely to continue. If that same rising price is with declining volume, the rise is not likely to continue. This week we pay homage to an easy to understand user-friendly volume indicator, the On-Balance Volume.
2. The On-Balance Volume (OBV) indicator, introduced by Joseph Granville in 1963, shows graphically the flow of volume in a stock. The OBV line is a running cumulative total of the daily volume numbers, adding volume on days the price goes up, subtracting on down-days. A volume bar chart and the resulting OBV are shown below, green bars for volume when the price increased that day, red bars signifying a drop in price (This is the convention on TC-2000).
OBV resulting from Volume pattern
3. 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!
4. In the next chart the OBV is plotted over the price showing 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-2
OBV plotted on Price chart
5. 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.
6. 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.
7. It matters not 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.
8. Lets take a look at a positive example of OBV, where it flagged a change in price before the fact. The chart below shows OBV plotted on the price chart for a recent pick. Notice how the price trend was down at the end of March through mid-April. However, the OBV told us the net volume was accumulating (more buys than sells). Price finally got the message the last half of April with a significant up-tick. Careful observation of the OBV gave us a great heads-up on where the price was likely to go.
VLNC Price Chart with OBV
9. Another recent pick shows the opposite signal, where in mid-December the price was rising without volume support. The trend of the OBV was doubtful with the rising price. The volume won!
OKE Price Chart with OBV

The next chart illustrates the importance of OBV direction vs. magnitude. The OBV had bottomed out toward the middle of April, forming what is called a "doubtful trend," not really knowing which way it was going. Then came a dramatic one-day spike in positive volume, but it then turned down for a few days. Point: While the steep rise in OBV may whisper "something big is going on," there was no evidence of sustained accumulation (buying) to move price higher. The down trend following the spike in OBV was reflected in the subsequent price pattern. It then became "doubtful" again.

CCCG Price chart with OBV
10. As an example looking forward, consider the price chart below with OBV on a recent pick to see if the signals we are receiving work out. The OBV strongly suggests accumulation the price hasn't responded to yet. Let's watch this in coming weeks.
PMRY Price chart with OBV
11. A final thought in this session regarding the OBV: This method allows us to take advantage of "insider trading" without having to get this inside information ourselves. We simply listen to market data. There is profound value in the use of this indicator. However, keep in mind; we used a few examples to make our point but every chart will not send us a message. In fact, most charts will simply show price following volume. That's not bad! We just need to be aware of opportunity when it shows up.
12. Last week we discussed the MACD oscillator. Next is a price chart with the MACD diverging with the price line in January. The tops of the MACD is going down while the price tops are staying about the same. This is a bearish divergence and was borne out by the resulting price direction.
PVSW price chart with MACD showing divergence
13. In general, a bearish divergence occurs when the tops of the indicator are going down while the price tops are going up. The other way, a bullish divergence is when the indicator bottoms are going up with price bottoms going down. The indicator will usually win this struggle with price.
14. 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.
15. Study Schedule:

June 4 - Stochastics - Using indicators together

June 11 - TC-2000 proprietary indicators (BOP, MS, TSV)

It is our intent to help our readers understand market strategies well enough to make informed decisions and understand the risks.

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