Technical analysis and its various indicators are widely used by traders for short-term trades and day trading to predict the future price movement of the asset. While there might be a plethora of indicators out there, the negative volume index, also known as NVI, holds a special place in a trader’s arsenal.
The negative volume index indicator is quite powerful and is one of the oldest indicators that are still used in modern-day trading. Continue reading to know more about the NVI and how it actually works.
What is the negative volume index (NVI)?
Conceptualized in the 1930s by a trader called Paul Dysart, the negative volume index tracks the volume of an asset to determine whether ‘smart money’ is in play or not. Here, the term ‘smart money’ is attributed to the money invested by institutional investors and is widely regarded as a representation of meaningful price movements in the asset.
For instance, if smart money is in play in an asset, the price of the asset would experience a meaningful movement that’s backed by facts and fundamentals. On the contrary, if smart money is inactive, then the price movements of an asset are usually regarded to be driven by emotions and other market events rather than solid facts.
According to the concept of NVI, when the markets are calm and the volume of an asset is light, smart money is said to be the most active. And on the other hand, when the markets are turbulent and the volume of an asset is heavy, smart money is said to be the least active.
How do you calculate the negative volume index (NVI)?
Unlike other technical indicators, calculating the negative volume index indicator is extremely easy. Here’s how it is done.
– The negative volume indexalways starts at a value of 1,000.
– If the volume of the asset decreases, you would need to add the percentage of price change of that asset to the value of 1,000 to arrive at the final NVI.
– Once you’ve calculated and recorded the NVIon the chart, it is compared with the 255-day exponential moving average (EMA) to determine the trend.
The negative volume index indicator increases when there is an increase in the price of the asset on low volume. Similarly, the NVI decreases when there is a decrease in the price of the asset on low volume.
In the event where the volume of the asset increases, the NVI stays constant irrespective of how the price of the asset moves. This is the reason why traders don’t bother calculating the NVI on high volume days since it doesn’t work.
How to use the negative volume index (NVI)?
Norman Fosback, the author of the popular book ‘Stock Market Logic’ has clearly outlined the method of using the NVI to ascertain the trend. Here’s how it is used.
Firstly, calculate the NVI of an asset.
Compare the NVIwith the 255-day exponential moving average (EMA) of the asset.
If the NVIwas above the 255-day EMA, he ascertained that there would be a 96% chance of a bull market.
If the NVIwas below the 255-day EMA, he ascertained that there would be a 53% chance of a bear market.
Negative volume index in action
Let’s take a more in depth look at the workings of the indicator. Here’s a chart with the price movement of an asset on the top-half and the NVI and the 255-day EMA on the bottom-half.
As you can see from this chart, the NVI is depicted in blue and the EMA is depicted in red. When the NVI is below its 255-day EMA, the price of the asset moves negatively indicating the presence of a bearish trend. And as the NVI moves above the 255-day EMA, the stock price moves positively indicating the presence of a bullish trend.
The negative volume index only gives you an idea of what the trend might be and doesn’t serve as a confirmation of the trend. Due to this reason, it is highly advisable to use the NVI along with other technical indicators to confirm the formation of a trend before entering into a trade. Since this indicator is primarily dependent on the volume of an asset, it is well-suited for use on broad market indices such as the Sensex and Nifty.
That said, this indicator can also be used to a certain extent on stocks with high volume and liquidity. However, the NVI cannot be used on stocks that are thinly traded in the market or on assets with little to no volume data such as currencies and commodities.