On Balance Volume (OBV) is a cumulative volume indicator that adds volume on up days and subtracts volume on down days, creating a running total that appears as a line in a lower indicator panel. Developed by Joe Granville in 1963, OBV operates on the principle that volume precedes price – smart money quietly accumulates before rallies and distributes before declines. For option traders, OBV reveals whether big players are buying or selling behind the scenes, helping avoid selling puts during distribution or calls during accumulation. Unlike price which can be manipulated short-term, volume represents real money commitment, making OBV a powerful tool for confirming trends and spotting divergences.
How OBV Works
OBV uses simple cumulative math:
The Calculation
- Up day (close > previous close): Add entire day’s volume to OBV
- Down day (close < previous close): Subtract entire day’s volume from OBV
- Unchanged (close = previous close): OBV stays same
Starting value is arbitrary – only direction matters.
Reading OBV
Rising OBV: More volume on up days
- Accumulation occurring
- Buyers in control
- Bullish for price
Falling OBV: More volume on down days
- Distribution occurring
- Sellers in control
- Bearish for price
Flat OBV: Balanced volume
- No clear direction
- Consolidation phase
- Wait for breakout
OBV Trend Confirmation
This lower indicator validates price trends:
Healthy Uptrend
- Price making higher highs
- OBV making higher highs
- Volume confirms rally
- Safe to sell puts on pullbacks
Healthy Downtrend
- Price making lower lows
- OBV making lower lows
- Volume confirms decline
- Safe to sell calls on rallies
Trend Weakness
- Price new highs, OBV lagging
- Or price new lows, OBV not confirming
- Trend may be ending
- Reduce position size
OBV Divergences
The most powerful OBV signals:
Bullish Divergence
Price lower low, OBV higher low:
- Sellers losing strength
- Accumulation occurring
- Reversal likely upward
- Prime put selling setup
Example:
- Stock falls from $50 to $45
- OBV higher than last $45 visit
- Smart money buying dip
- Sell $43 puts confidently
Bearish Divergence
Price higher high, OBV lower high:
- Buyers losing strength
- Distribution occurring
- Reversal likely downward
- Prime call selling setup
Example:
- Stock rallies from $50 to $55
- OBV lower than last $55 visit
- Smart money selling rally
- Sell $57 calls confidently
OBV Breakout Confirmation
Critical for option strike selection:
True Breakout
Price breaks resistance + OBV new high:
False Breakout
Price breaks resistance + OBV lagging:
- No volume conviction
- Likely to fail
- Perfect call selling setup
- Place strikes above highs
This lower indicator separates real from fake moves.
OBV Line Breaks
OBV has its own support/resistance:
OBV Support/Resistance
- Draw trend lines on OBV itself
- Breaks often precede price moves
- Early warning system
- Position accordingly
Example:
Advanced OBV Analysis
Sophisticated uses of this lower indicator:
OBV Rate of Change
Apply momentum to OBV:
- Rising OBV accelerating = very bullish
- Rising OBV decelerating = caution
- Helps time entries
- Avoid selling against acceleration
OBV Moving Average
Add 20 or 50 MA to OBV:
Multi-Timeframe OBV
- Daily OBV: Short-term accumulation
- Weekly OBV: Institutional activity
- Alignment = strong signal
- Conflict = wait
OBV for Weekly Options
Applying to short-term trades:
5-Day OBV Analysis
For weekly options:
- Check 5-day OBV trend
- Compare to price action
- Look for divergences
- Confirm with daily OBV
Intraday OBV
For day trading:
- 15-minute OBV
- Shows intraday accumulation
- Spot distribution into strength
- Time premium sales perfectly
Combining OBV with Price
This lower indicator needs context:
OBV + Support/Resistance
High probability setup:
- Price at support
- OBV turning up
- Accumulation starting
- Sell puts below support
OBV + Moving Averages
Trend confirmation:
OBV + Other Volume Indicators
Multiple confirmation:
- OBV showing accumulation
- Money Flow positive
- Accumulation/Distribution line up
- Strong bullish signal
Common OBV Mistakes
Absolute Values: OBV level meaningless, only direction Ignoring Divergences: Most powerful signals No Price Context: OBV alone insufficient Wrong Timeframe: Match to option duration
Building an OBV System
Systematic approach using OBV:
OBV Divergence Scanner
Weekly routine:
- Scan for 52-week price highs
- Check if OBV at new highs
- Flag divergences
- Sell calls on bearish divergences
- Track success rate
Rules for OBV Trading
- Never sell puts during distribution (falling OBV)
- Never sell calls during accumulation (rising OBV)
- Always confirm breakouts with OBV
- Size up when OBV aligns with price
- Exit if OBV diverges against position
OBV Limitations
Understanding what OBV can’t do:
Single Large Trades: Can skew readings Low Volume Stocks: Less reliable News Gaps: May distort accumulation Splits/Dividends: Require adjustment
Use OBV as confirmation, not sole indicator.
Key Takeaways
On Balance Volume (OBV):
- Lower indicator tracking cumulative volume
- Adds volume on up days, subtracts on down
- Shows accumulation vs distribution
- Divergences signal reversals
- Confirms or denies breakouts
- Simple but powerful
- Volume precedes price
OBV is the option seller’s insider information, revealing what smart money is doing before price reflects it. This lower indicator cuts through the noise by focusing on the only thing that matters – where real money is flowing. Master OBV divergences and breakout confirmation to avoid selling premium against institutional positioning. Remember: price can lie short-term, but volume tells the truth, and OBV keeps the running score.