Last Updated on August 15, 2023
The Negative Volume Index (NVI) is a cumulative indicator that shows how days of low volume affect price movements. Opposite to the Positive Volume Index (PVI), which generates trading signals based on an increase in trading volume, NVI focuses on down-volume days.
In this blog post, we take an in-depth look at the NVI and the differences and similarities to the PVI. We also review its calculation and examine how to recognize NVI’s signals.
What is the Negative Volume Index?
The NVI indicator assumes that large-scale investors (“smart money”) like institutional investors and funds – are more active when the trading volume is low. In other words, the NVI tracks the movements of professional investors by monitoring day-on-day volume changes.
This is based on the idea that days of significantly high volume are periods when “uninformed” investors are dominating the market.
The NVI appears as a technical indication line that uses the security’s price and volume to help traders see price changes on down-volume days.
Just like the PVI, the NVI was also designed by Paul Dysart in the 1930s. The two indicators became increasingly popular in the 1970s following the launch of Norman Fosback’s book “Stock Market Logic.”
The NVI is considered among the best trendlines for monitoring smart money investors’ actions. As opposed to the NVI, the PVI trendlines are more related to periods of increased volume, which come as a result of the involvement of both smart money and noise traders in the market.
The NVI is particularly useful when a security’s price declines following a period of high-volume trading. While the indicator primarily tracks the trading moves of smart money investors, it is generally advised to use NVI and PVI in conjunction. Together they provide a broader picture of how a security’s price is affected by the volume.
Calculating the Negative Volume Index
The formula for calculating the NVI is based on the change in volume between two trading days. As such, the NVI’s value changes only if today’s volume has decreased from yesterday. On the other hand, if today’s volume is higher than the previous day, the NVI remains unchanged.
That said, if today’s volume has decreased from yesterday, the NVI formula is as follows:
NVI = Yesterday’s NVI + ((Close – Yesterday’s close)/Yesterday’s close) * Yesterday’s NVI)
If the current volume is larger or equal to yesterday’s volume, then:
NVI = Yesterday’s NVI
The NVI generally trends downward since depreciating prices are more often associated with decreasing volume.
Trading with the Negative Volume Index
The NVI is among the widely used volume indicators. Below we can see how it can help identify a trend, according to Fosback.
The first step is calculating the NVI for the particular security. Then, a trader should compare the NVI against the 255-day exponential moving average (EMA). According to Fosback, if the NVI is above the 255-day EMA, there is roughly a 96% chance that a bull market is afoot. On the other hand, if the index is below the 255-day EMA, there is a 53% chance that bears have taken over, Fosback says.
However, it is important to note that the market hasn’t necessarily turned bearish if the NVI is below the long-term MA. It rather means that the chance of turning bullish is below 50%. Further, in instances where multiple crossovers occur in a short period, the NVI indicator can sometimes experience whipsaws. Such situations make it difficult to identify the market trend.
How to Recognize Signals
The PVI and NVI were designed to generate trade signals when a security’s price is on the rise while the volume is declining.
As we have noted, the indicator is based on the idea that price movements on days of high volume occur because uninformed traders dominate the market. In contrast, price changes on low-volume days are led by smart money investors.
That said, an increase in NVI suggests that institutional investors and other informed market participants are buying the security. Meanwhile, trend reversals can be spotted amid crossovers with a signal line – the 255-day MA of the NVI.
Put simply, if the NVI crosses above the signal line, it is a buy signal. Alternatively, if it falls below the signal line, there is a sell signal. The default setting for the NVI’s EMA is 255 days.
While the NVI was mainly designed for major stock indexes, chartists often use it with ETFs, stocks, and more. However, the NVI can vary between different stocks and indexes. For instance, the NVI can sometimes be above the 255-day EMA on the chart of an index like the S&P 500 while being more bearish on an individual stock.
When it comes to day trading, applying the NVI to a daily chart can be useful for gaining a broader market view. However, even traders that are more focused on short-term investments should keep an eye on the long-term trends as trading in their direction can improve the odds of being successful.
Also, even though it can provide trade signals on its own, it is always advised to use NVI in conjunction with other technical indicators and analysis techniques.
Negative Volume Index and Positive Volume Index
In contrast to NVI, the PVI provides trading signals based on an increase in trading volume. Just like the NVI, the PVI can also be used for market indexes and individual securities. While the NVI monitors the movements of smart money investors, the PVI assumes that days of high volume are driven by less informed, crowd-following investors.
A common signal generated by the PVI is when the indicator drops below the 1-year MA. When this happens, Fosback says there is a 67% chance that a bear market is in progress. Conversely, if the indicator moves above the 1-year MA from below, it represents a sign of a bull market. This bullish trend typically prevails as long as the index remains above the 1-year MA.
There are investors who rely solely on the NVI, while some prefer to use the two in conjunction.
Generally, investors are advised to use both since they offer a broader perspective together. This is because both indicators represent trendlines that help investors keep track of price changes based on volume. Specifically, NVI trendlines are mainly used for monitoring the impact smart money investors are making, while the PVI trendlines are more focused on market effects associated with high volume.
Using Both Together
Based on the assumptions that low-volume days are periods when smart money investors are dominating the market and high-volume periods are driven by casual investors, traders can use both PVI and NVI on a security’s chart to look for divergences.
For example, let’s say the PVI is declining. This is often seen as a buying opportunity because it could mean that casual investors are exiting the market. Likewise, if the NVI is rising, it could suggest that institutional investors are buying a security – a potential buying opportunity.
One should keep in mind that even though the two indicators can generate trading signals, their primary use is for learning about market conditions and analyzing market volume, as well as keeping an eye on the behavior of institutional and casual investors.
Summary
The Negative Volume Index is a technical indication line that looks at both the volume and price to help traders better understand how price movements are affected on days of decreasing trading volume. The NVI is focused on smart money. It is advised to use both PVI and NVI together to better understand how the volume influences the price.
