Editor’s note: This is a brief abstract of the 2013 Charles H. Dow Award winning paper.
For readers who are not familiar with the indicator, On Balance Volume (OBV) is designed to measure whether there is more buying or selling pressure in the market. It is a cumulative indicator, always adding the current day’s value to the previous value of the indicator. OBV is found by adding the total volume on days when the price closes higher and subtracting the total volume on down days. It can be calculated for major stock market indexes using the total volume for a stock exchange, for example charting the Dow Jones Industrial Average and calculating OBV with the total volume reported by the New York Stock Exchange. It can also be calculated for individual stocks using only the volume in that stock. Using a simplified example, we can consider a stock that closed up 1 point on volume of 10,000 shares. If OBV was 100,000 yesterday, we would 10,000 to it and OBV would now be 110,000. If the stock closed down one point on that volume, OBV would fall to 90,000. Because the direction of OBV is used in the analysis, the price value of the indicator doesn’t matter. That means you can use any starting date and still have the same OBV line as any other trader. OBV is usually charted as a solid line under the price. When OBV is moving in the same direction as price, traders usually consider that to be confirmation of a healthy price trend. A declining OBV confirms a bear market and a rising OBV signals a healthy price advance is underway. Divergences between OBV and price can be used to predict reversals in price. If price is going up as OBV declines, traders expect prices to fall. In price declines while OBV is rising, traders look for a bottom in prices. Several examples of OBV are included in the Chart of the Month feature.
How On Balance Volume (OBV) came about is a story of multiple innovators, working independently, coming up with the same idea of relating volume to the direction of closing price by maintaining a cumulative total. The calculation was described in 1932 by Wall Street economist Paul Clay. In 1951, Frank Vignola and his wife Maude V. Woods, publishing in San Francisco, used OBV for stock trading. In 1948, Edward B. Gotthelf, a New York commodities trader, was using his “On-Balance Volume and Open Interest Method.” Until shown otherwise, we must believe these innovators did not know each other or of the others’ work. Joseph E. Granville claims that OBV came to him in 1961, but by then others had developed OBV.
On April 26, 1932, the American Statistical Association (ASA) held a dinner meeting in the Hotel Governor Clinton in Manhattan. The organization of statisticians, the ASA is the second oldest professional affiliation in the United States having been founded in 1839.
The topic for discussion was “Forecasting Methods Successfully Used Since 1928.” Four speakers were invited.
The second speaker was Paul Clay, whom the minutes recorded as being an investment counselor. The final presenter was James F. Hughes, who had worked alongside of Leonard P. Ayres (ASA’s President in 1926) to create the AdvanceDecline Line.
Addressing the audience of 233 guests:
“Mr. Clay stated that he now felt that, in the past, he had underestimated the importance of the New York Stock Market itself in the industrial and financial affairs of the United States, and even of the world.… The movements of the stock market represent the net result of the industry of the United States and a considerable proportion of the rest of the civilized world. Because of this conclusion, Mr. Clay had been led to construct a new index similar, in general, to the Dow theory, but not based upon the Dow methods. This index number he calls a psycho-technical index. It contains five principal elements:
1. A volume index number made by giving the sign of the price movement to the daily volumes, and accumulating the plus and minus movements….
The psycho-technical index built out of these five elements looks much like a price chart with the false movements eliminated.
It has the very distinct merit of often moving contrary to the course of the market itself. This index is not used independently, but rather in conjunction with the economic indexes which formerly constituted the chief reliance of Mr. Clay.”
Clay used OBV as one element of an index rather than as an independent indicator. In spite of intense research, additional information about Clay’s index has not been found.
In 1951, M. V. Woods Market Analysis and Research published a report (authored and copyrighted by Frank Vignola) entitled The Price-Curve Plan of Stock Market Trading with Countertrend Signal Analysis. Vignola wrote that:
“Volume is the pressure gauge for measuring the balance between supply and demand, and for determining the quality of buying and selling in a stock or market Average.… VOLUME CAN BE ANALYZED TO BETTER ADVANTAGE when data is arranged in a time series or on a cumulative basis.” (emphasis in original)
Vignola used three series to analyze volume which he integrated with a 10-day moving aggregate of daily price changes in stocks or market indices called the “Price-Curve.” The first series was a 10-day moving total of aggregate volume called the “Aggregate Volume Curve.” Saturday’s volume was doubled to account for the short session. The second was a 30-day moving total of aggregate volume named the “Major Volume Curve.” These are time based series, but Vignola’s third series differentiated between buying and selling volume.
The third series was the “Continuous Volume Curve” which “is made by adding the total daily market volume of trading to a base index figure, each day the market advances; and by subtracting the volume on days when the market declines.” Saturday’s volume was not doubled in this series. Vignola suggested a base number of at least 50 or 100 million. He did not use the term “cumulative volume.”
According to Vignola, this curve:
“Is an auxiliary timing device used in connection with other technical condition indices. It is extremely sensitive to price movement, and will indicate the relative balance between buying and selling at the peaks and valleys of market trends.
MINOR FLUCTUATIONS OF THE CONTINUOUS VOLUME CURVE follow the daily trend of the Industrial Average, and it is often difficult to distinguish the difference between them. This does not hold true with intermediate and major trends. The main price trend will often precede or lag volume action. The Continuous Volume Curve is a key to the supply and demand equation. Interpretation of this curve is based on a knowledge of divergence, and the breaking of established trend-lines and previously established points of trend reversal.” (emphasis in original)
Vignola determined an up or down day by the number of issues advancing or declining each day, which he believed to be preferable because they represent the action of the entire market, not the price trend of a few stocks. However, he recommended that if “the number of issues traded [is] not available, use the closing price of the Dow-Jones Industrial Average.” Vignola’s daily OBV was based on the direction of price or the DJIA, but he maintained a weekly Continuous Volume Curve based on weekly advances and declines.
CHART 1 Continuous Volume Curve, April – August 1949
Chart 1 shows the Dow Jones Industrials, a Continuous Volume Curve, and several trend lines. For simplicity, he omitted the last three digits of volume.
According to Vignola, the Continuous Volume Curve confirms an indication of strength (weakness) in a Price-Curve and an Aggregate Volume Curve. The Continuous Volume Curve gives a buy (sell) signal when it breaks above (below) one of its intermediate or major trend lines confirming the strength or weakness shown in the other two curves. All three curves have to trend in unison for a buy or sell signal to be given.
CHART 2 Vignola’s Price and Volume Series, April – July 1949
Edward B. Gotthelf (1908 – 1985) was an upstairs commodities trader from 1935 through 1945. In 1950, he became a member of the New York Mercantile Exchange and Chicago Mercantile Exchange. Later he acquired the basic COMMODEX® system, “one of the first futures trading systems when it was inaugurated in the 1950s.” Both father and son Philip refined COMMODEX®.
According to Philip, his father “developed a relatively simple method of measuring accumulation,” which Edward Gotthelf called “the On-Balance Volume and Open Interest Method.” Edward Gotthelf’s “notes reveal the development of this term as far back as 1948.”
Gotthelf assigned a “+” to the price for the day when price closed above the previous day’s level. If volume increased on the same day, the volume component received a “+.” A rise in open interest from the previous day was assigned a “+.” However, if price moved up, and volume moved down, the day’s volume was assigned a “-.When price and volume moved down, volume was assigned a “+.”
Figure [3] recreates a worksheet.
FIGURE [3] Gotthelf’s On-Balance Volume and Open Interest Method
Over time, the net plus and minus days would be counted. If on balance net pluses outnumbered net minuses, Gotthelf would be a buyer. If minuses exceeded pluses, he would sell. If net pluses and minuses were about even, he would stay neutral. Trading tactics were developed based on observations of the on balance plus and minus series.
Gotthelf believed his OBV method detected accumulation (open interest and volume rise) and distribution (the reverse) which led to overbought or oversold markets. Overextended markets, notably those following a long period of accumulation, could experience dramatic corrections which in turn gave buy and sell signals.
While Granville popularized OBV, Paul Clay and clearly, Frank Vignola and Maude Vignola Woods, had earlier originated OBV, while Edward B. Gotthelf used the term. Volume was uniquely important to the analytical work of Granville’s predecessors. They believed volume could presage the direction of price, and a cumulative count was a valid way to analyze buying and selling volume. All were intelligent observers of volume in stock and futures markets who merit recognition.
The full paper can be found at http://go.mta.org/8552.
