What is Negative Volume Index

A negative volume index, or NVI is one of the many technical indicators traders use to predict an asset's future price movement. It is a powerful indicator traders use to get the best out of the activity. So what is NVI, its calculation methodology, and other aspects? Let's find out.

What is Negative Volume Index?

NVI is a technical analysis indicator developed by Paul Dysart in the 1930s. Its primary objective is to assess the correlation between volume and price movements in the financial markets. While traditional volume indicators emphasize the relationship between increasing volume and rising prices, the NVI focuses on the inverse scenario – the connection between declining volume and falling prices.

The NVI is founded on the premise that during periods of low trading volume, the market is typically dominated by well-informed institutional investors. In contrast, high-volume periods may involve uninformed or less sophisticated retail investors. The index assumes that smart money, i.e. institutional investors, is more likely to sell during low-volume sessions, causing prices to drop.

NVI Calculation

The calculation of NVI involves a cumulative process. To compute NVI, the index is initialized at a base value (usually 1,000), and subsequent values are derived from the prior NVI value. The calculation follows these steps:

• If the current trading volume is lower than the previous day's volume, the NVI remains unchanged
• If the current trading volume is higher than the previous day's volume, the NVI increases by a percentage equivalent to the percentage price change
• If the current trading volume is equal to the previous day's volume, the NVI remains unchanged

The formula to calculate NVI is:

Where:

NVIt – Negative Volume Index at time t

Pt – Price or the index level at time t

Interpreting NVI

The primary purpose of the NVI is to identify potential reversals in the market's downward trend. By analyzing the indicator's values over time, traders and analysts can glean insights into market sentiment and determine potential buying opportunities. When the NVI starts to rise consistently, it suggests that informed investors are stepping into the market, which may indicate a reversal in the downward price trend.

It is important to note that the NVI is primarily used along with other technical indicators to validate signals and reduce false positives. Commonly paired indicators include moving averages, trendlines, and oscillators like the Relative Strength Index (RSI).

Benefits and Limitations of NVI

NVI provides several benefits to traders and investors. It offers a unique perspective on market behavior, particularly during periods of declining volume. By highlighting the potential impact of institutional investors and smart money, the NVI can help traders anticipate market reversals and make informed trading decisions.

However, like any indicator, it has its limitations. It should be used in collaboration and as part of a comprehensive technical analysis approach. Additionally, the NVI might perform poorly in markets heavily influenced by retail investors or during periods of unusual market conditions, such as high volatility or significant news events.

Also, NVI can be susceptible to whipsaws, which occur when multiple crossovers happen rapidly. These whipsaws can complicate investors' ability to ascertain the market trend and interpret price movements accurately. Therefore, it is advisable to consider the Positive Volume Index (PVI) alongside the NVI and make trading decisions when both indices provide consistent signals. This approach helps mitigate the risk of false signals and enhances the reliability of the analysis.

The Final Word

NVI is a valuable tool for market participants seeking to understand and anticipate shifts in market trends. The NVI offers unique insights into market sentiment and potential reversal points by focusing on declining volume and its impact on price movements.

It can enhance trading strategies and help market participants make more informed decisions when used alongside other indicators. However, remember that no indicator guarantees accurate predictions and prudent risk management should always accompany technical analysis.