The Negative Volume Index (NVI) relies on cumulative change in volume to measure the influence of smart money in trading. And this indicator can be your key to unlocking the secret of when to trade or when to flee from the market.
- NVI is based on the notion that smart money, generally institutional investors, may cause price adjustments with less trading volume than the rest of the market.
- While the NVI is a valuable tool, it should not be used in isolation. Traders are advised to combine it with other indicators and analysis techniques for a more comprehensive view of the market.
- Given its long-term nature and the specific insights it provides, the NVI is not a primary tool for day traders. Instead, it is better suited for multi-timeframe analysis.
In this guide, we will cover everything you need to know about the Negative Volume Index indicator, including how to use the indicator and implement the Negative Volume Index trading strategy.
Table of Contents
What is the Negative Volume Index Indicator?
The Negative Volume Index, often referred to as NVI is a cumulative indicator designed to help the not-so-smart-money traders (retail traders) gauge the influence of smart money in the market.
Developed by Paul Dysart in the 1930s, the NVI operates on a unique principle – it assumes that smart money, typically institutional investors, can drive price movements with less volume compared to the rest of the market participants.
Norman Fosback, renowned for his book “Stock Market Logic,” introduced a compelling technique to analyze the NVI. He compared the NVI with its one-year (255-bar) exponential moving average.
When the NVI surpasses this moving average, there’s a 96% chance of a bull market being in progress. Conversely, if the NVI falls below the average, there’s a 53% chance of a bearish sentiment which is pretty impressive.
If you’re inclined to calculate the NVI manually, here’s a straightforward formula:
NVI = (CPtoday – CPyesterdayCPyesterday NVIPrevious
Where:
NVI: Negative Volume Index
NVIprevious: Negative Volume Index of the previous trading day
CPtoday: Closing price for the current trading day
CPyesterday: Closing price for the previous trading day
How to Use the Negative Volume Index Indicator in Trading
First off, add the indicator to your chart from the “Indicators” tab if you’re using TradingView. The indicator comes pre-loaded with the 255 EMA on this trading platform. If you’re using the MetaTrader trading platforms, however, you might have to download it and load it manually to your charts.
So, here’s how you would use the NVI indicator:
Bull Market Indicator: If the NVI is above the 255 EMA, it suggests a high probability of a bull market. In fact, according to Norman Fosback’s research, this scenario implies a remarkable 96% chance of a bullish trend being in progress.
Bear Market Warning: Conversely, if the NVI falls below the 255 EMA, it serves as a cautionary signal, indicating a potential bear market. Fosback’s research also reveals that in this situation, there is a 53% likelihood of a bearish trend. It’s crucial to pay attention to this warning, as it can help traders avoid significant losses during market downturns.
To effectively use the NVI, it’s important to understand how it responds to various market events and conditions. The NVI is a dynamic indicator that reacts to changes in both price and volume. Here’s a quick summary of its behavior:
- NVI on Positive Days: On days when the stock’s price experiences a positive change accompanied by low volume, the NVI tends to rise. This indicates that institutional traders are potentially influencing the price positively, even with reduced trading activity.
- NVI on Negative Days: Conversely, on days when the stock’s price declines amidst low volume, the NVI typically falls. This suggests that smart money might be taking bearish positions or exiting existing ones, contributing to the downward pressure on the stock.
- NVI on High Trading Volume Days: Importantly, the NVI remains unchanged on days of higher trading volume, regardless of whether the price is rising or falling. This aspect of the indicator is designed to filter out the noise created by higher-than-average volume, focusing solely on the influence of smart money.
Given its long-term nature and the specific insights it provides, the NVI is not a primary tool for day traders. Instead, it is better suited for multi-timeframe analyses, allowing traders and investors to make well-informed decisions by aligning with broader market trends.
Negative Volume Index Indicator Trading Strategy
Here’s a simple NVI indicator trading strategy. It involves the use of the NVI to gauge the overall trend and the 50-EMA to call your trade entry or exit signals. You don’t have to use the 50-EMA, though. You can use any other indicator or trading tool. Whatever floats your boat.
Step 1: Confirm the trend with the NVI
The first thing you want to see on your chart is the NVI. It’ll tell who’s in control of the market; the bulls or the bears. When the bears are in control, the NVI line falls below the 255 EMA. But when the bulls are in control, the NVI line rises above the 255-EMA.
But why is this important? Because you only want to enter bullish trades when the bulls are in control and bearish trades when the bears are in control. Anything contrary could be deadly for your trading account.
The chart above is the EURUSD pair in the 4-hour timeframe, and it’s a perfect example of what we’re talking about. See how the market is bearish.
Step 2: Trade Entry
Once you know the direction of your trades, what’s left is to scout for trade entries. As we already mentioned, we’re using the 50-EMA.
Whenever the price falls below the 50 EMA while the NVI is bearish, we have our bearish entry. Whenever the 50-EMA crosses above the price while the NVI is bullish, we have a confirmed bullish trade. Otherwise, don’t pull the trade trigger.
Continuing with our 4-hour EURUSD chart, you’ll notice that we only took sell trades because the NVI was bearish. Whenever the price crossed over the 50-EMA to the upside, we did not take a bullish trade. And that’s how you do it.
Step 3: Setting Stop Loss and Target Profit
Effective risk management is a fundamental aspect of trading. Here’s how to determine them in the context of the NVI and EMA 50 strategy:
For bullish positions, set your stop loss just below the most recent swing low. This level acts as a safety net, limiting your losses if the trade doesn’t go as planned. Additionally, consider exiting the market when the price is poised to cross below the EMA 50, signifying a potential trend reversal.
But for a bearish position, and like on our chart below, set your stop loss just above the swing high. Likewise, exit the trade when the price is on the verge of crossing above the EMA 50, indicating a potential shift in the trend.
Negative Volume Index Indicator – Pros and Cons
Let’s quickly review the benefits and limitations of using the NVI indicator.
Benefits of Using the Negative Volume Index Indicator
The NVI is designed to detect where smart money is active in the market. It excels at identifying trends driven by institutional investors and can provide a clearer picture of market sentiment. It is, therefore, one of the best indicators to combine with the Smart Money Concept trading strategy.
One of the significant advantages of the indicator is its suitability for longer-term trading. It helps traders and investors identify sustained trends, making it valuable for those with a more extended time horizon.
Pros
- Useful smart money insight
- Long-term trend identification
- Divergence detection
Limitations of the Negative Volume Index Indicator
Generally, the NVI is less suited for day traders who rely on very short-term charts. Its strength lies in detecting longer-term trends, which may not align with the objectives of day trading. Also, while the NVI is a valuable tool, it should not be used in isolation. Traders are advised to combine it with other indicators and analysis techniques for a more comprehensive view of the market.
Cons
- Limited for high-frequency trading
- Not ideal for day traders
- Prone to false signals
- Confirmation required to take trades
Key Takeaways
Key Takeaways
- NVI operates on the premise that smart money, often institutional investors, can produce price changes with less trading volume compared to the rest of the market.
- Rising NVI on days of positive price changes with lower volume indicates active smart money involvement, while falling NVI on days of negative price changes with lower volume suggests smart money may be exiting positions.
- Norman Fosback’s analysis shows that when NVI is above its one-year moving average, there’s a 96% chance of a bull market, and when it is below, there is a 53% chance of a bear market. However, NVI is most effective when used in conjunction with other analysis techniques.
- To gain a comprehensive view of how price is influenced by volume, traders often follow both the Negative Volume Index (NVI) and Positive Volume Index (PVI). NVI primarily reflects smart money movements, while PVI covers a broader range of market trends.
Frequently Asked Questions on the Negative Volume Index (NVI) Indicator
Here are some of the most common questions about the NVI indicator:
Is the Negative Volume Index (NVI) a standalone indicator?
While the NVI can provide valuable insights into smart money movements, it’s recommended to use it alongside other analysis techniques. Combining the NVI with moving averages, trend analysis, and complementary indicators like the Relative Strength Index (RSI) can enhance the accuracy of your trading decisions.
How does a negative volume index help in identifying price trends?
The NVI is a technical indicator that helps traders identify market trends. It is a cumulative indicator, which means that current values will be utilized to calculate future values for a previous time. The NVI is designed to track smart money and analyze market trends.
How do I interpret the NVI in practical trading scenarios?
Interpreting the NVI involves understanding its movements. When the NVI rises on days of positive price changes with lower volume, it suggests smart money is actively buying. Conversely, if the NVI falls on days of negative price changes with lower volume, it indicates potential smart money selling. When NVI remains unchanged on high-volume days, it implies that volume alone isn’t driving price.
Risk Disclosure: The information provided in this article is not intended to give financial advice, recommend investments, guarantee profits, or shield you from losses. Our content is only for informational purposes and to help you understand the risks and complexity of these markets by providing objective analysis. Before trading, carefully consider your experience, financial goals, and risk tolerance. Trading involves significant potential for financial loss and isn't suitable for everyone.
