OBV, PVT, MACD - notes on indicators PDF

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notes on indicators...

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On-Balance Volume; Price-volume Trend; MACD Overview: In this module, we will first look at two volume indicators, On-Balance Volume (OBV) and price/volume trend, as a way of discovering if volume is confirming price. Next, we will look at an indicator called the Moving Average Convergence/Divergence (MACD), which combines a trend following with an overbought/oversold component.

Objectives: On completion of this section, you should be able to: 1. Identify when price is diverging from or being confirmed by a security's volume. 2. Determine when the trend of a security has significantly reversed, using the MACD indicator.

Lesson: On Balance Volume (OBV) is an indicator created by Joseph Granville. His objective is to make sure that volume is confirming the underlying direction in price. There are times when a security will advance in price on very light volume. There is little power in such a move. The move can reverse quickly because it has little sustained interest to propel it. On the other hand, there are times when a stock is falling in price, but is doing so with very little volume. At these times, it will not take much new buyer interest to reverse the trend and push prices up. Granville's OBV takes an arbitrary number, such as 5,000,000, as its starting point. It then multiplies the price change of a security on a given day times the volume. If, for instance, IBM advanced 1 point on 100,000 shares, it would add 100,000 to the OBV. The cumulative line would now read 5,100,000. If on the next day, IBM fell 1 point, back to its previous price, but did so on only 50,000 shares - 50,000 would be subtracted from the cumulative OBV line. The cumulative OBV line would now read 5,050,000. Note, that even though the price of IBM is unchanged in two days, the on balance volume is in fact higher, showing that there were more shares traded on the up day than on the down day. This increase in the on balance volume line would be interpreted as a sign of underlying strength.

In reading a chart, it is important to pay attention to the overall direction of the OBV line as opposed to the absolute numerical value. If the absolute direction is up, than this is a bullish sign. If the absolute direction is down, than it is bearish. If the OBV line is sideways, then the stock is essentially neutral. The OBV line can help the investor in several ways. First, one wants to always confirm that the upward or downward movement in price is being confirmed by the OBV line. If there is a divergence between price and the OBV line, it is very possible that the stock will soon reverse trend. Second, the OBV line will often signal an upcoming move in the price of the stock before it happens. In other words, the OBV line breaks out of a "consolidation" pattern before price does. By paying attention to the OBV line, one can get a jump on price movement. The OBV line has been criticized as an indicator lacking "refinement" because it adds all the shares traded on that day times the price change to the cumulative OBV line. Many software packages include a more sensitive indicator called "price volume trend", which, instead of calculating an absolute number, takes the day's price change as a percentage of the underlying security. If a stock, for instance, moved 1 point and was previously selling at 10, the price volume selling line would be increased by 10% times the volume of that day's trading. If on the other hand, the stock were trading at 100 and it increased 1 point, it would mean that the price volume trend line increased by only 1% times that day's volume. Generally, OBV and price volume trend give an internally consistent message about a stock. When the two are in conflict, however, it is probably wise to trust the PVT indicator. MACD also known as "moving average convergence/divergence" was developed by Gerald Appel. Appel's goal was to combine in one indicator a trend following device with a reading of overbought and oversold. The MACD indicator consists of two lines. The first line is a 12 period minus a 26 period

exponentially smoothed moving average of the security's price. An exponentially smoothed moving averaged gives proportionately more weighting to recent price changes. The second line, called the trigger line, is a 9 period exponentially smoothed moving average of price. This line is called the "signal line". There are several ways in which the MACD line can be helpful to the investor. First, a signal is given when the 12 minus 26 line crosses through the pre-calculated zero point of the MACD indicator. If it crosses through to the upside, it is considered a buy signal. If it crosses through to the downside, it is a sell signal.

Another important way to use MACD is for determining confirmation and divergence. There are times when a stock's price may continue to advance while its MACD line forms a double top or even a series of declining peaks. In such a case, the MACD is warning that the advance is coming to an end and may soon reverse course. On the other hand, when prices continue to decline, but the MACD forms a series of rising peaks, it is very likely that in time the price of the stock will bottom and begin to move upward. A third way of using MACD is as an overbought or oversold indicator, similar to RSI or stochastics. If one brings up several years of data on a chart, one can establish a level where MACD has previously peaked or bottomed on several occasions. Such a level can often give the investor advance warning as to when a move may terminate.

As with RSI and stochastics, MACD should always be applied in both its daily and weekly timeframes. One wants to always ensure that both the daily and weekly MACD are in harmony before investing. MACD is one of the most powerful of indicators and its signals should be taken very seriously.

Reading: Murphy, John. The Visual Investor. Pages 50-54; 121-130.

Interactivity: Bring up a chart of the Royal Bank from www.bigchart.com. First, apply the OBV indicator on a daily and weekly basis to determine if there is confirmation or divergence in the price trend. Next, use the MACD on both the daily and weekly basis to gauge the overall trend....