On-Balance Volume, or OBV, is a technical indicator that operates based on the assumption that price movements are preceded by volume movements. Traders use this tool to forecast future trends and gauge bull and bear strengths, particularly in the short-term. Forex markets are well-suited for the type of analysis OBV aims to provide since currency pair trading involves so much short-term arbitrage opportunities.
Forex trading volume acts a little differently than traditional stock trading volume, because there are two competing monetary mediums rather than the supply and demand of a trading instrument as expressed through a single currency. The assumptions made in the OBV formula make it uniquely able to provide a traditional volume reading, however.
Mechanically, the OBV is not difficult to understand. Whenever one day's trading price closes above the trading price for the day before, trading volume is added to a running OBV line. Conversely, volume is subtracted from the running total when the current day's prices close below the close for the day before; you want to enter trends that have the OBV's support and attempt to short trends that do not.
Contrast the OBV trendline with the currency pair price action trendline. Divergence occurs when the OBV pattern does not move in concert with the price, while confirmation of trend strength can be signaled when the two move together. If the volume does not support a new price movement, you may want to avoid the trade because there is a stronger chance of the price retracing quickly.
Remember that the OBV is a leading indicator, and it can be balanced by lagging indicators. Add a moving average line to the OBV to look for OBV line breakouts; you can confirm a breakout in the price if the OBV indicator makes a concurrent breakout.