Trading breakouts is a popular technical trading method that can be applied in a variety of styles. Breakouts form after a period of retracement and/or consolidation on the market in question.
Breakouts are generally spotted by price action breaking a trend line or a moving average. Signals on indicators like the MACD can also be used. Then momentum and volume strength can be assessed to determine whether the breakout is likely to continue into a new trend.
This article will focus on confirming volume strength in a breakout. On Balance Volume, or OBV, is one indicator that can be useful in this confirmation process.
Developed by Joe Granville, OBV measures the strength of price action based on volume by adding the volume of positive days and subtracting the volume of negative days. The line drawn can then be used to gauge momentum and strength in a given trend. Divergence between OBV and trend direction can be taken as an early warning sign that the trend is about to change.
OBV can also be very useful in confirming price breakouts after consolidations/retracements as discussed above. We can use this confirmation to further analyse Elliott based Wave 4 trades. Chart 1 below shows an example of a Wave 4 trade set-up on Intersil Holding Corporation (ISIL:NASD). By drawing a trend line on OBV based on the last two peaks, we can see that OBV broke out at the same time as the EBOT (and the trend line), confirming that there is reasonable volume support to the move.
Chart 1 – OBV On ISIL
click chart for more detail
When drawing these trend lines there are no hard and fast rules and some may even disagree with the way the above trend line is drawn. The main thing is that it links the OBV peaks (or troughs) that line up with the significant highs (or lows) formed during the retracement right up to where the breakout on the stock has occurred. Generally, breakouts that occur simultaneously on the stock and OBV give the best results.
For those of you who have read previous articles on Wave 4 Trade analysis, Chart 2 shows some additional points of interest. First, the pattern found RSI support at Wave 4 with a previous low as circled – an indication that Wave 4 may be over. Second, the break above the EBOT also coincided with a change to an uptrend based on the Daily Trend Filter. This also suggests that Wave 4 is now over and the Index is ready to move into Wave 5.
Chart 2 - ISIL OBV & Trend Filter
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After seeing a set-up like this on an Index you may wish to trade it directly or take a position in a Banking stock with a similar pattern.
OBV is a simple yet powerful filter when properly used. If there is not much volume behind a move, there’s a good chance that there’s not much money either. Using indicators like OBV to follow the big money generally has better results than going it alone.