Negative Volume Index

Negative Volume Index (NVI) – Strategy, Rules, Returns

While there are many technical analysis indicators available to the trading community, the Negative Volume Index (NVI) is a unique tool for analyzing the financial markets. What do you know about this indicator?

Created by Paul Dysart, the Negative Volume Index (NVI) is a cumulative indicator that tracks negative changes in trading volume to anticipate when smart money is active in the market. The indicator is based on the assumption that price moves started by smart money require less volume than those initiated by the retail crowd.

In this post, we will take a look at everything you need to know about this indicator: what it is, how it works, and how you can use it to improve your trading strategies. Let’s dive in!

Key takeaways

  • The index measures prices’ trends during periods when the volume is declining. The price index is only adjusted when the volume has decreased from the previous day. The indicator remains unchanged if the volume did not change or was positive.
  • It is based on the assumption that price moves started by smart money (institutional traders) require less volume than those initiated by the retail crowd.
  • We show you a backtested NVI trading strategy complete with trading rules and settings that has historically performed very well.

What is the Negative Volume Index (NVI)?

The Negative Volume Index (NVI) is a cumulative indicator that tracks negative changes in trading volume to anticipate when smart money is active in the market.

It was created by Paul Dysart to identify trends in a market and how down volume days affect price movements. It is based on the assumption that price moves started by smart money (institutional traders) require less volume than those initiated by the retail crowd.

The index measures prices’ trends during periods when the volume is declining. The price index is only adjusted when the volume has decreased from the previous day. The indicator remains unchanged if the volume did not change or was positive.

The NVI is a cumulative indicator, meaning that it uses the previous period’s values of the indicator in calculating the current period’s value. Its value rises on days the price closes higher on lower volume, declines on days the price closes lower on lower volume, and stays unchanged on days of higher volume regardless of whether the price closed higher or lower.

Below is an example of what the Negative Index looks like on a chart (Amibroker):

Negative Volume Index example
Negative Volume Index example

How does NVI help traders in the stock market?

The NVI helps traders in the stock market by showing when the price movement happens on low volume, suggesting the activities of smart money. Traders believe that when smart money is involved, the trend stays longer, offering opportunities to make money.

On the other hand, when uninformed retail traders are behind the price move, the trend won’t last because of their herd mentality.

Thus, traders can use the NVI to identify potentially strong trending days and take advantage of the price moves. It may be necessary to combine the NVI with the PVI (positive volume index) to fully understand how price is affected by both negative and positive volume changes.

Negative Volume Index (NVI) trading strategy – trading rules, returns, performance

We have explained what the Negative Volume Index is, and now it’s time to put the indicator to the test.

We make the following trading rules:

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These two simple trading rules have returned the following equity curve for the S&P 500 (SPY) from 1993 until today (dividends included):

Negative Volume Index trading strategy
Negative Volume Index trading strategy

Let’s look at the statistics and trading performance metrics:

Table of Key Statistics (Negative Volume Index)

StatisticsValue
Number of trades309
Average gain per trade0.88%
CAGR (Compound Annual Growth Rate)8.7%
Win rate75%
Average winning trade1.7%
Average losing trade-1.7%
Max drawdown-28%
Time invested in the market21%
Risk-adjusted return40%

This table summarizes the key statistics and trading performance metrics, indicating a high win rate of 75% alongside a notable CAGR of 8.7%. The risk-adjusted return of 40% suggests strong performance relative to the time invested in the market. However, the significant drawdown of -28% indicates potential risks associated with the trading strategy.

Considering the strategy is only invested 21% of the time, meaning it stays outside the market 79% of the time, the returns are pretty good: it has almost managed to keep up with buy and hold.

We optimized the strategy, and the sweet spot for the best settings seems to be between 15 and 30. However, the trading rules work well in most or less all settings, and not only for the S&P 500.

Negative Volume Index – complete code

Here’s the complete code for the strategy (Amibroker):

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Why should traders pay attention to NVI?

Traders should pay attention to the NVI because it shows how the price moves on low volume days, and if the price is rising on low volume days, it’s a good sign that the trend is strong. It is believed that retail traders are uninformed and it’s their herd mentality that causes unsustainable huge volume trading days. Knowing how to avoid such fake moves can be useful to traders. That’s what the NVI offers.

The NVI is based on the assumption that price trends started by smart money require less volume than those initiated by the retail crowd. The idea is that if a trend continues even as trading volume declines, it is a strong trend, and the price is likely to continue to rise even on low volume days because the un-informed traders are not the market drivers.

When was NVI introduced in trading and finance?

The NVI was developed in the 1930s when Paul Dysart was studying the effects of volume on price movements. Although it was one of the oldest technical indicators created for analyzing stock price movement and volume changes, it wasn’t until the 1970s when Norman Fosback explained it in his book, “Stock Market Logic”, that the indicator gained popularity in the world of trading and finance.

Who developed the Negative Volume Index?

The Negative Volume Index was developed by Paul L. Dysart, Jr in the 1930s. In 1936, Dysart came up with the idea that ‘volume is the driving force in the market’. So, he started accumulating two series of advances and declines based on whether the volume increased or decreased compared to the previous day’s volume.

The cumulative series for the days when volume had been lesser than the previous day, he called the Negative Volume Index (NVI). The other one where volume had been greater than the previous day, he named the Positive Volume Index (PVI).

How does NVI differ from other trading indicators?

The NVI differs from other trading indicators in that it shows how days with low trading volume affect price movements. It doesn’t just show the relationship between volume and the price, rather, it specifically focuses on how the price moves on low volume days.

The idea is that if a trend continues even as trading volume declines, it is a strong trend, and the price is likely to continue to rise because smart money is behind the price movement. Institutional traders have the tools to know when to drive the market with minimal resistance.

What factors influence NVI’s calculations?

The only factors that influence NVI’s calculation are the price and volume changes. But that is only if the volume for the current day is less than that of the day before — if not, the NVI doesn’t change. In other words, NVI’s calculation depends on how volume for the present day compares to the previous day’s trading volume.

The NVI changes only if the current day’s volume is lower than that of the previous day. When this is the case, then the price changes are considered to get the actual NVI value for the current day. If the price closes higher, the NVI value rises, and if the price closes lower, the NVI decreases. However, if the volume is higher than or the same as that of the previous day, the NVI remains unchanged regardless of whether the price closed higher or lower.

Can NVI be used in conjunction with other indicators?

Yes, the NVI can be used with other indicators to get the best trading opportunities. It is not advisable to use the indicator alone to predict the market direction and find the right entry levels — it should be used with other indicators that tell the story of the market from a different perspective or combined with price action analysis to know if the market structure supports the direction you want to trade.

Since the indicator shows who is likely behind a trend, you can combine it with any indicator that shows the direction of the trend or oscillators that show pullback reversal points so you can enter at the right level.

Where can traders access NVI data?

Traders can access the NVI data from any trading platform that offers market data or subscribe to a market data vendor. Some trading platforms that offer market data include TradingView and NinjaTrader. TradeStation can also allow for it if subscribed via a market data vendor. On TradingView, there are many custom NVI indicators created by traders that one can use.

What are the key components of NVI?

The key components of NVI are the price and the previous period’s NVI. And since the previous NVI is dependent on negative volume changes, the key components of the NVI are price changes and negative volume changes.

Regarding the volume changes, the NVI specifically depends on how volume for the present day compares to the previous day’s trading volume. Its value changes only if the current day’s volume is lower than that of the previous day. In the case of price changes, if the price closes higher, the NVI value rises, and if the price closes lower, the NVI decreases.

However, if the volume is higher than or the same as that of the previous day, the NVI remains unchanged regardless of whether the price closed higher or lower.

How does NVI interpret volume changes?

The NVI interprets volume changes by comparing the present day’s volume to the previous day’s volume to know if the present day’s NVI would be calculated or if the value remains what was last calculated. NVI’s value changes only if the current day’s volume is lower than that of the previous day. It is only after this condition is met that the price changes are considered to get the actual NVI value for the current day.

If the volume is higher than or the same as that of the previous day, the NVI remains unchanged regardless of whether the price closed higher or lower.

Why is NVI considered a momentum indicator?

The NVI is considered a momentum indicator because it shows how the price moves relative to volume changes. It indicates that the price is moving in whatever direction despite a decline in volume compared to the previous day. This is taken to mean that smart money is in the market.

To even make the NVI more powerful as a momentum indicator, you can combine it with its exponential moving average such that when the NVI crosses its EMA, it indicates positive momentum in the market — a potential buy opportunity.

How is NVI calculated?

The NVI is calculated using the formula below:

NVIc = NVIp + [(Pt – Py)/Py]*NVIp

Where:

NVIc = Current NVI

NVIp = Previous NVI

Pt = Today’s Closing Price

Py = Yesterday’s Closing Price

To calculate the first NVI, you have to set the primary NVI level on the starting date at a round figure. Then, you calculate the subsequent values based on the formula above but only on days where the volume is lower than the preceding day’s volume.

If the current day’s trading volume is equal to or higher than the previous day’s volume, the NVI will not be calculated and the last calculated value is retained.

Can NVI predict market trends accurately?

Yes and no. The NVI can predict market trends accurately sometimes, but not all the time. No indicator can predict market trends accurately all the time. If there was, the trader who discovered it would be the richest person on the planet. Having said that, let’s look at how the NVI predict can accurately predict market trends.

The NVI can show when the trend is rising on low trading volume, indicating that there is not much resistance on the path of price advance. So, the price is likely to keep trending higher.

What are the limitations of using NVI?

The limitations of using the NVI include:

  • It doesn’t work well in a bearish market: The NVI doesn’t work well in a bearish market and neither can it be used to predict a bearish market. When combined with its long-term moving average, the indicator falling below the moving average does not indicate a bearish market.
  • It cannot be used to create a sell strategy: The indicator is not a good predictor of a sell signal. Don’t use it to find a shorting opportunity — it can only work in a long-only strategy.
  • It doesn’t work in a choppy market: The NVI is prone to whipsaws in the market.

How frequently should traders monitor NVI?

How frequently traders should monitor the NVI depends on their trading style. A swing trader would have to monitor more frequently than a position trader. However, based on the way the index is calculated, the least a swing trader can do is to monitor it every day — at the end of the trading day. A position trader may choose to monitor less frequently, but if he or she is calculating it manually, they need to check for volume changes every day.

What are some real-world examples of NVI in action?

Here are some real-world examples of the NVI in action:

Example 1: A buy signal on US30 D1 timeframe:

In the D1 chart below, you can see the NVI (red line) crossed above its 255-day moving average (blue line). After staying flat for a while (indicating either no volume change or positive volume change), the NVI ticked upward, as the price stated closing higher. That’s a signal that the market is more likely to keep rising since it’s rising on a low volume — a buying opportunity for a swing trade.

Negative volume Index (NVI)
Negative volume Index (NVI)

Example 2: A buy signal on US30 H1 timeframe:

In the HI chart below, you can see that the NVI is already above the 255-day EMA. So, it’s safe to look for buying opportunities. Notice how the NVI made an uptick after the price showed it’s reversing from a pullback with a dragonfly doji candle pattern. This shows that the price is eager to rise on a lower volume, presenting a buy signal.

Negative value Index trading rules
Negative value Index trading rules

How does NVI respond to market volatility?

How the NVI responds to market volatility depends on the market condition. During periods of low volatility, the NVI does not change much because the market is in a sideways movement without a strong trend. If the price is spiking all over the place, the NVI will be prone to whipsaws. But when the price is trending strongly upward, the NVI can give a clear signal.

Can NVI be applied to different asset classes?

Yes, the NVI can be applied to different asset classes, as long as the asset posts reliable trading volume for each trading day. The volume data is necessary to know whether the current day’s trading volume is less than that of the previous day so that the NVI can be calculated.

As a result of this condition, the NVI can be applied to assets like commodities, futures, and bonds, but may not be applied to spot forex trading because, in spot forex trading, there is no central exchange, and the day’s trading volume cannot be accurately known.

How reliable is NVI in identifying bearish trends?

The NVI is not reliable in identifying bearish trends. It doesn’t work well in a bearish market and, as such, should not be used to predict a bearish market. Traders often combine the indicator with its long-term moving average to better predict the trend. In an uptrend, when the indicator crosses above the moving average, it is a strong confirmation of the uptrend.

However, the opposite is not true for a bearish trend — the indicator falling below the moving average does not indicate a reversal to a bearish market; instead, it implies that the probability of the bullish trend continuing has reduced.

What are the potential risks associated with relying solely on NVI?

The potential risks associated with relying solely on the NVI include:

  • False signals: The NVI is prone to whipsaws, giving frequent false signals. This is especially true during a choppy market or a bearish trend.
  • Assuming a bearish market when there is none: Using the indicator alone could make you assume there is a bear market when there is none.
  • Inadequate risk management: As the indicator does not tell you how much to risk and where to place stop-loss orders, you may not manage risk adequately if you trade with it alone.

How do traders use NVI to confirm trend reversals?

To use the NVI to confirm trend reversals, traders combine the NVI indicator with its long-period (often 200-day or 255-day) moving average. When the NVI crosses over the 200-period moving average of the NVI, it indicates a trend reversal. This only works for a bullish reversal and not for a bearish reversal. For a bullish reversal, an uptrend is assumed when the NVI crosses above its 200-period moving average. When that happens, traders start looking for buying opportunities.

What role does NVI play in risk management strategies?

The NVI does not directly play any role in risk management strategies because it neither tells the trader how much position size to use, nor which level to keep their stop-loss order.

However, the indicator can be used to formulate a good buy-only trading strategy that can be backtested to find the most optimal risk management variables to use while trading. This can tell the trader the right amount to risk per trade, the appropriate position size per trade, and the right level for their stop-loss order.

Can NVI be customized to suit individual trading styles?

Yes, the NVI can be customized to suit individual trading styles. It is up to the trader to use the timeframe that suits their trading. A swing trader can easily use the indicator on the daily timeframe to trade, while an intraday trader may use the indicator to confirm a bullish trend for the day and then use other tools to refine their entry and find the right time to go long on the market.

How can beginners incorporate NVI into their trading arsenal effectively?

To effectively incorporate the NVI into their trading arsenal, beginners have to first understand the market and how it works. They should know what indicators are and how they differ from one another in the way they tell their stories about the market action. Then, they narrow down on the NVI to understand what it does.

After understanding the basics, they should look to create and backtest a robust strategy using the NVI and other tools in their arsenal. With this, they can have a reliable NVI-based strategy to execute.

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