No matter what you invest in, you will always come across the eternal question of when to sell or if the investment involves others, how to tell when people are panic selling.  When we analyze the stock market, there actually is a very good indicator called On-Balance Volume (OBV) that we can use to help us identify these time when there is panic selling occurring.  The best part is that the calculation is relatively simple.

What is OBV:

On-balance volume (OBV) is a technical indicator of momentum, using volume changes to make price predictions. The OBV is a cummulative total of volume (positive and negative). Per Investopedia, there are three rules implemented when calculating the OBV:

1. If today’s closing price is higher than yesterday’s closing price, then: Current OBV = Previous OBV + today’s volume

2. If today’s closing price is lower than yesterday’s closing price, then: Current OBV = Previous OBV – today’s volume

3. If today’s closing price equals yesterday’s closing price, then: Current OBV = Previous OBV

OBV Example:

The easiest way to understand how OBV works is to use an example. Again, courtesy of Investopedia, here is how it works. Below is a list of 10 days’ worth of a hypothetical stock’s closing price and volume:

1. Day one: closing price equals $10, volume equals 25,200 shares

2. Day two: closing price equals $10.15, volume equals 30,000 shares

3. Day three: closing price equals $10.17, volume equals 25,600 shares

4. Day four: closing price equals $10.13, volume equals 32,000 shares

5. Day five: closing price equals $10.11, volume equals 23,000 shares

6. Day six: closing price equals $10.15, volume equals 40,000 shares

7. Day seven: closing price equals $10.20, volume equals 36,000 shares

8. Day eight: closing price equals $10.20, volume equals 20,500 shares

9. Day nine: closing price equals $10.22, volume equals 23,000 shares

10. Day 10: closing price equals $10.21, volume equals 27,500 shares

As can be seen, days two, three, six, seven and nine are up days, so these trading volumes are added to the OBV. Days four, five and 10 are down days, so these trading volumes are subtracted from the OBV. On day eight, no changes are made to the OBV since the closing price did not change. Given the days, the OBV for each of the 10 days is:

1. Day one OBV = 0

2. Day two OBV = 0 + 30,000 = 30,000

3. Day three OBV = 30,000 + 25,600 = 55,600

4. Day four OBV = 55,600 – 32,000 = 23,600

5. Day five OBV = 23,600 – 23,000 = 600

6. Day six OBV = 600 + 40,000 = 40,600

7. Day seven OBV = 40,600 + 36,000 = 76,600

8. Day eight OBV = 76,600

9. Day nine OBV = 76,600 + 23,000 = 99,600

10. Day 10 OBV = 99,600 – 27,500 = 72,100

OBV is only an indicator and certainly has its limitations. Big spikes in volume can throw off the indicator for quite a while. But I’m a big proponent of studying volume, and firmly believe that volume is the most difficult thing in the market to manipulate. Volume tells you if price action is authentic. Volume confirms market sentiment. In any event, while OBV certainly has its limitations, this is an easy visual of whether people are panic selling.

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