Traders and investors commonly rely on the Negative Volume Index (NVI), a popular technical indicator, for evaluating the strength of a stock’s trend within the market. Based on earlier work done by Paul Dysart in the 1930s, the NVI was further developed by Norman Fosback, a respected financial researcher and technical analyst, who introduced it in his 1985 book “Stock Market Logic”. The NVI is based on the idea that, during a bull market, trading volume tends to be higher on up days than on down days, while during a bear market, trading volume tends to be higher on down days than on up days.
The NVI calculates a cumulative indicator that adds or subtracts a portion of the day’s volume based on the stock’s closing price. If the stock closed up but the volume was lower than the previous day’s volume, the NVI will subtract a portion of that day’s volume. Conversely, if the stock closed down but the volume was lower than the previous day’s volume, the NVI will add a portion of that day’s volume. As a result, the NVI is more responsive to changes in volume than in price, making it a valuable tool for identifying trend reversals and confirming trend strength.
To sum up, the Negative Volume Index is a technical indicator that uses changes in trading volume to predict trend reversals in the stock market. It calculates a cumulative indicator that adds or subtracts a portion of the day’s volume based on the stock’s closing price. This makes the NVI more sensitive to changes in volume than in price, allowing traders and investors to identify trend reversals and assess trend strength.
Also, check out the Positive Volume Index (PVI) for more insights.
Computing the Negative Volume Index
One way to assess the momentum of a stock’s trend is by using the Negative Volume Index (NVI), a popular technical indicator, that takes into account fluctuations in trading volume. The NVI calculation formula is defined as follows:
NVI = NVI[previous day] + [(Today's Closing Price - Yesterday's Closing Price) / Yesterday's Closing Price] * [Today's Volume / Yesterday's Volume] * NVI[previous day]
In this formula, NVI[previous day] is the value of the NVI from the previous day, and NVI is the value of the NVI for the current day.
The calculation involves three main components:
1. The percentage change in price between yesterday’s closing price and today’s closing price: (Today’s Closing Price – Yesterday’s Closing Price) / Yesterday’s Closing Price
2. The ratio of today’s volume to yesterday’s volume: Today’s Volume / Yesterday’s Volume
3. The previous day’s NVI value: NVI[previous day]
To calculate the NVI, the percentage change in price is multiplied by the ratio of today’s volume to yesterday’s volume, and then multiplied by the previous day’s NVI value. This result is added to the previous day’s NVI value to obtain the current day’s NVI value.
Since the NVI is cumulative, each day’s value is added to the previous day’s value to obtain the current value. This allows the NVI to provide a long-term view of market trends and identify major trend reversals.
In summary, the NVI formula calculates the NVI value for a given day by adding the percentage change in price to the ratio of today’s volume to yesterday’s volume, and multiplying that result by the previous day’s NVI value. The NVI is a cumulative indicator that provides a long-term view of market trends and helps identify major trend reversals.
Understanding the Negative Volume Index in technical analysis
Traders and analysts often depend on the Negative Volume Index (NVI), a frequently utilized technical analysis tool, to identify trend reversals and confirm trend strength using trading volume data. Here are some reasons why the NVI is favored by traders and analysts:
Volume tends to lead price movements, making changes in volume a reliable indicator of potential trend reversals. The NVI takes advantage of this by using changes in volume to predict trend changes.
Price movements can be unpredictable and noisy, but changes in trading volume are more reliable indicators of trend changes. By focusing on volume, the NVI helps to filter out some of the noise in price movements and provide a clearer signal of trend direction.
Buying and selling pressure
The NVI measures buying and selling pressure by analyzing changes in volume on up days and down days. Higher volume on up days suggests more active buyers, while higher volume on down days suggests more active sellers. Traders can make better decisions by utilizing this information.
Price trend confirmation
In some cases, price trends and volume trends can diverge. For example, a stock may be trending upward in price, but if the volume is decreasing, it suggests that the trend may not be sustainable. The NVI can help to confirm or contradict price trends by analyzing changes in volume.
NVI provides valuable insights into investor behavior by indicating the presence of uninformed crowd-following investors on high-volume days and the strategic moves of smart money on low-volume days. It effectively reveals the activities of the smart money in the market.
According to Fosback, when the NVI surpasses its 1-year moving average, there is a 96% chance of a bull market. Conversely, when the NVI falls below its 1-year moving average, the odds of a bull market are approximately 50/50. Therefore, the NVI serves as a highly reliable indicator for identifying bull markets.
See table below: Based on data from 1941 through 1975 / Source: “Stock Market Logic” by Norman Fosback
|Indicator||Relative to 1-year Moving Average||Probability Bull Market in progress||Probability Bear Market in progress|
Overall, the NVI is a valuable tool that provides insight into market trends and helps traders make informed trading decisions. By analyzing changes in trading volume, the NVI can help identify potential trend reversals and provide a clearer picture of market direction.
Norman Fosback‘s suggestions on how to use the Negative Volume Index
Norman Fosback, the creator of the Negative Volume Index (NVI), shared his insights on how traders can effectively use the NVI to improve their trading strategies. Below are some of his thoughts on how to use the NVI:
Confirm price trends
Fosback believed that the NVI is a useful tool to confirm price trends. If the NVI is rising along with prices, it suggests that the trend is strong and likely to continue. Conversely, if the NVI is falling while prices are rising, it could be a warning sign that the trend may not be sustainable.
Identify trend reversals
Fosback also suggested that the NVI can be used to identify potential trend reversals. If the NVI is falling while prices are also falling, it suggests that sellers are in control of the market and that a bearish trend may be developing. If the NVI is rising while prices are falling, it could be a sign that buyers are stepping in and that a bullish trend may be emerging.
Look for divergences
Traders should also look for divergences between the NVI and the price trend. If the NVI is moving in the opposite direction of the price trend, it could be a warning sign that the trend is weakening or reversing.
Use NVI to confirm support and resistance levels
Fosback recommended that traders use the NVI to confirm support and resistance levels in the market. If the NVI is rising while prices are testing a support level, it suggests that buyers are becoming more active and that the support level is likely to hold. Conversely, if the NVI is falling while prices are testing a resistance level, it suggests that sellers are becoming more active and that the resistance level may hold.
Adjust the time frame to match your trading style
Traders should adjust the time frame of the NVI to match their trading style. By doing so, they can tailor the NVI to their specific trading style and increase its effectiveness in identifying potential trading opportunities.
Be aware of potential false signals
Fosback cautioned traders to be mindful of potential false signals with the NVI. Sudden spikes in volume on a down day could cause the NVI to rise even if the trend is still bearish. Traders should always confirm the NVI signal with other indicators and market analysis before making trading decisions.
Combine with other indicators
Fosback recommended that traders use the NVI in conjunction with other technical indicators, such as moving averages or other volume-based indicators, to gain a more complete picture of market trends.
Overall, Fosback believed that the NVI is a powerful tool for traders and analysts who want to gain insight into market trends and make more informed trading decisions. By analyzing changes in trading volume, the NVI can help identify potential trend reversals and confirm the strength of a trend, making it a valuable addition to any trader’s toolkit.
Advantages & Limitations of the Negative Volume Index
Here are some advantages and limitations of using the Negative Volume Index (NVI) in trading:
- Confirmation of Price Trends: The Negative Volume Index (NVI) can confirm the strength and direction of price trends. Traders can determine whether the trend is strong or weak, and whether it is likely to continue or reverse by analyzing changes in trading volume.
- Identification of Potential Trend Reversals: The NVI can also be used to identify potential trend reversals. If the NVI is moving in the opposite direction of the price trend, it may indicate that the trend is weakening or reversing.
- Flexibility: The NVI can be used in combination with other technical indicators and market analysis, making it a flexible tool for traders and analysts. It can also be adjusted to match the trader’s preferred time frame, making it useful for both short-term and long-term trading.
- False Signals: The NVI, like all technical indicators, can produce false signals. Unexpected spikes in volume or low-volume periods can cause the NVI to move in unexpected ways, leading to false trading signals.
- Lagging Indicator: The NVI is a lagging indicator, meaning it relies on past trading volume data to produce its signals. This can result in delayed or missed trading opportunities, especially during periods of rapid market movements.
- Limited Scope: The NVI analyzes changes in trading volume and has a narrower scope than other technical indicators that analyze a wider range of market data. As a result, it may not be effective in all market conditions or trading scenarios.
The Negative Volume Index is a technical indicator that traders can use to gain insights into the strength and direction of the market. It can help to confirm price trends and identify potential trend reversals by analyzing changes in trading volume. The NVI is a flexible tool that can be used alongside other technical indicators and market analysis to provide a more complete picture of market trends. It is a valuable addition to any trader’s toolkit, regardless of their experience level.
Keep in mind that no technical indicator can predict market movements with absolute certainty, and the NVI is no exception. False signals are possible, and it’s crucial for traders to combine the NVI with other market analysis techniques, risk management strategies, and their own trading experience and intuition. Moreover, traders should remember that past performance is not necessarily indicative of future results, and should never rely solely on the NVI to make trading decisions.