What is Negative Volume Index or NVI?

Technical indicators are essential tools for traders and investors who seek to understand and predict market behavior. Among these indicators, the Negative Volume Index (NVI) holds a unique place. It is particularly useful for identifying market trends based on periods of declining trading volume. Developed by Paul Dysart, NVI aims to track the behavior of professional or “smart money” investors, under the assumption that these investors act during quieter periods of the market, when trading volumes decrease.

In this blog, we will dive deep into what the Negative Volume Index is, how it works, and how investors can utilize it to make informed trading decisions.

Understanding the Negative Volume Index (NVI)

The Negative Volume Index is a cumulative technical indicator that focuses on days when trading volume declines compared to the previous day. While the Positive Volume Index (PVI) focuses on high-volume trading days, NVI looks at periods when fewer trades are taking place, under the assumption that professional traders are more active during these times.

The Assumption Behind NVI

The core premise of NVI is that professional traders tend to trade during quieter market periods, when there is less noise and emotion-driven buying and selling from retail investors. On the other hand, retail traders tend to be more active during high-volume days, contributing to more volatile price movements.

Thus, NVI is designed to detect the influence of professional traders on price movements during periods of reduced trading volume. By analyzing these price movements, traders can gain insights into potential trends that might not be visible during high-volume days.

How to Calculate the Negative Volume Index

The formula for calculating NVI is similar to that of the Positive Volume Index but applies only on days when trading volume decreases compared to the previous day. The NVI remains unchanged if the volume increases.

Here’s the formula:

NVI = Previous NVI + [(Today’s Closing Price – Yesterday’s Closing Price) / Yesterday’s Closing Price] * Previous NVI

This calculation is applied only when today’s trading volume is lower than the previous day’s volume. If today’s volume is equal to or higher than the previous day’s volume, the NVI remains unchanged.

Practical Example

Let’s assume that a stock has an NVI of 1,000 on day one, with a closing price of $100. On day two, the stock’s closing price rises to $102, but the trading volume decreases compared to the previous day. Using the NVI formula, the new NVI will be:

NVI (Day 2) = 1,000 + [(102 – 100) / 100] * 1,000 = 1,000 + 20 = 1,020

This calculation shows an increase in NVI, reflecting the price increase during a period of declining volume.

Interpretation of the Negative Volume Index

The Negative Volume Index is primarily used to confirm long-term market trends. Since NVI tracks price changes during periods of declining volume, it can help traders identify the behavior of professional investors and long-term market sentiment.

Key Interpretations:

1. Bullish Market: When the NVI rises over time and aligns with rising stock prices, it is considered a bullish signal. This indicates that smart money is supporting the upward trend.
2. Bearish Market: A falling NVI during periods of declining prices suggests that the market is weakening, and professional traders are reducing their positions.
3. Market Confirmation: NVI is commonly used to confirm the strength of a trend. If NVI moves in the same direction as the broader market, it can signal that the trend is supported by professional traders.

Advantages of the Negative Volume Index

The Negative Volume Index offers several benefits to traders and investors who wish to gain a deeper understanding of market trends during low-volume periods:

1. Focus on Smart Money: By analyzing price movements during declining volume, NVI helps traders detect the actions of professional traders, who are more likely to act during quieter market conditions.
2. Long-Term Trend Analysis: NVI is particularly useful for identifying long-term trends in the market. Since professional traders often take positions with a long-term outlook, the NVI can help investors gauge the sustainability of a market trend.
3. Simple Calculation: Like the PVI, the NVI is easy to calculate and interpret, making it accessible to both novice and experienced traders.
4. Confirmation of Market Signals: When used in combination with other indicators, such as the Positive Volume Index or moving averages, NVI can confirm broader market signals, offering a more comprehensive picture of market trends.

Limitations of the Negative Volume Index

While the NVI is a valuable tool, it is important to understand its limitations:

1. Ignores High-Volume Days: NVI focuses only on low-volume days, meaning it can miss important signals that occur on high-volume trading days.
2. Lagging Indicator: Like many technical indicators, NVI is a lagging indicator, meaning it reflects past price and volume changes rather than predicting future movements.
3. Not a Standalone Tool: NVI works best when used in conjunction with other technical indicators. Relying solely on NVI for trading decisions can result in incomplete analysis.

Combining NVI with Other Indicators

To enhance the effectiveness of NVI, traders often use it alongside other technical indicators. This allows for a more robust analysis of market conditions and helps to reduce the impact of NVI’s limitations.

1. Positive Volume Index (PVI): Since NVI focuses on low-volume days and PVI focuses on high-volume days, combining the two can give traders a more complete picture of market behavior. By comparing the movements of NVI and PVI, traders can better understand the actions of both professional and retail investors.
2. Moving Averages: Adding moving averages to the NVI can help smooth out short-term fluctuations and provide a clearer view of long-term trends.
3. Relative Strength Index (RSI): Using NVI with the RSI can help traders identify overbought or oversold conditions in the market, enhancing decision-making for trade entries and exits.
4. Volume Moving Average: Applying a moving average to trading volume can help confirm the signals provided by NVI, especially when it comes to identifying significant shifts in market sentiment.

Real-World Applications of Negative Volume Index

NVI has practical applications in various trading scenarios. Here’s how traders and investors can use it in the real world:

1. Identifying Market Trends: By tracking the NVI, traders can identify long-term trends and confirm whether a market is in a bullish or bearish phase.
2. Spotting Reversals: A sudden change in the NVI, especially when confirmed by other indicators like RSI or moving averages, can signal a potential reversal in the market trend.
3. Gauging Investor Sentiment: Since NVI focuses on professional trader activity, it can be used as a proxy for market sentiment. A rising NVI indicates that professional traders are supporting the market, while a falling NVI suggests they are pulling back.
4. Risk Management: NVI can be an important tool in risk management strategies. By analyzing long-term trends based on professional trader behavior, investors can make more informed decisions about when to enter or exit trades.

Case Study: Using NVI to Analyze a Stock

Let’s look at an example of how NVI can be applied to analyze a stock’s performance.

Consider a stock that has been trading in a steady uptrend, with regular increases in price. Over time, the NVI also shows a consistent upward movement, confirming that professional traders are supporting the uptrend. However, suddenly, the NVI starts to decline while the stock’s price continues to rise. This divergence between price and NVI could be a warning sign that the uptrend is losing strength, and professional traders are reducing their positions.

In this case, a trader might decide to take profits or reduce their exposure to the stock, anticipating a potential price correction.

Conclusion: Is NVI a Valuable Tool?

The Negative Volume Index is a unique and valuable tool for traders and investors who want to understand market trends during low-volume periods. By focusing on the behavior of professional traders, NVI offers insights that can help confirm long-term market trends and identify potential reversals. While it has its limitations, such as its focus on low-volume days and its status as a lagging indicator, NVI can be a powerful addition to a trader’s toolkit when used in combination with other technical indicators.

Whether you are a long-term investor or an active trader, the Negative Volume Index can help you make more informed decisions, reduce risk, and better understand market behavior during periods of declining volume.