Key Highlights
The Positive Volume Index (PVI) is a technical indicator that tracks changes in trading volume from the previous day. The concept behind PVI is that as trading volume rises, investors tend to align with market trends.
PVI is a useful indicator to distinguish between "smart money" investments made by institutions and investment made by retail investors.
PVI analyses the correlation between trading volume and price changes, especially on days with high trading volume
When used in combination with a 1-year moving average (MA), a rising PVI suggests a bullish trend. Conversely, a falling PVI indicates a bearish trend.
Premise Behind the PVI
Before going deep into what is PVI, let’s understand the rationale behind using it. The stock market is quite dynamic. Money moves back and forth between various types of investors and traders as they purchase and sell equities on stock exchanges. However, not all capital entering the stock market is equal in terms of technical analysis. Some investments are referred to as "smart money,". Investments under the management of institutions like banks are a good example. The expression “smart money” implies that institutional investors decide sensibly when to purchase and sell in the market.
On the other end of the scale, we have the cash that regular investors are pumping in and who are typically prone to making emotional and wrong judgments. This causes irrational trading decisions and erratic market fluctuations. You must monitor both kinds of investments to develop and implement your trading plan. A technical indicator that can assist you in doing that is the positive volume index (PVI).
Definition of PVI
The Positive Volume Index (PVI) is a technical analysis indicator that studies the correlation between trading volume and price changes to pinpoint trends in the stock market. It compares the previous and present day’s trade volumes at a given moment. Thus, provides information regarding the price change. Investors utilise these price changes to enter the stock market or modify their existing positions to limit losses.
The Positive Volume Index (PVI) is typically calculated daily. It is a useful indicator for intraday traders. PVI) is rarely used alone. It is often compared to various technical indicators, such as moving averages and the relative strength index.
Understanding the Positive Volume Index (PVI)
The Positive Volume Index tracks price movements in securities or indexes that coincide with an increase in transaction volume. Paul Dysart first created this indicator for market indices using advance-decline figures. Later, Norman Fosback modified it for use with individual securities, creating the version that is mainly in use nowadays.
Mechanism of PVI
PVI changes in line with security prices. However, it occurs only on days when trading volume is higher than the day before. In other words, the PVI changes if the volume of trade during the current period is larger than during the prior period. On the other hand, if the volume does not rise, PVI stays the same.
Calculation of the Positive Volume Index
If the trading volume is larger than the previous day's volume, the PVI is computed by taking the PVI from the previous day and adding it to the percentage change in price. The PVI stays the same if the trade volume is lower than the previous day. Another method of calculating the PVI is to do it cumulatively over a predetermined time frame, such as a week or a month.
You must include the trading volume for today and yesterday when calculating today's PVI. The PVI will alter if today's volume is higher than yesterday's volume. The pvi formula is as follows.
PVI = Yesterday’s PVI + [[(Close – Yesterday’s Close) / Yesterday’s Close] * Yesterday’s PVI
When the volume is less than or equal to the previous day’s volume, the formula is simply:
PVI = Yesterday’s PVI
Here’s a step-by-step guide to calculating the PVI indicator.
1. Determine the trade volume throughout the two days: You must have trade volume data for at least two consecutive days to compute PVI. Let's say, for instance, that the volume is 1,000 shares on Day 1 and 2,000 shares on Day 2.
2. Assess if the volume increased or decreased: Compare the trading volume of Day 2 with Day 1. In this example, there is an increase in volume since Day 2's volume (2,000 shares) was larger than Day 1's volume (1,000 shares).
3. Determine the % price change: Next, determine the difference in price between the two days. Let’s say the stock price is Rs.550 on Day 1 and Rs.500 on Day 2. So, the percentage difference is ((550 - 500) / 500) x 100 = 10%.
4. Determine the PVI value: Add the price change % to the PVI number from Day 1 if Day 2's volume is higher than Day 1's.
How to Recognise Signals
The Positive Volume Index often sends a signal when it drops below its 1-year MA. According to Norman Fosback, who applied PVI to individual equities, when this occurs, there is a roughly 67% likelihood that the market is bearish. On the other hand, if the PVI rises over the 1-year MA from below, this indicates a bullish trend. So, it shows a positive market sentiment. This trend should continue as long as the PVI remains above the 1-year MA.
However, the PVI trading signals are based on probabilities. Mr. Fosback emphasised this fact in his books. So, one shouldn't expect the indicator to be completely accurate. Investors and analysts typically analyse the PVI against the 1-year MA to discover and validate prospective trends and price reversals.
Trading with the Positive Volume Index
The PVI indicator's default exponential moving average (EMA) is 255 days. If the PVI is higher than its 1-year moving average, it shows that investors who follow the herd are more positive. On the other hand, if the PVI is below the MA, it means that people are becoming more pessimistic, and a price decrease is more likely.
Traders often seek for crossings when utilising the PVI on trading charts by comparing a 9-period MA against a 255-period MA. For instance, if the PVI goes above the 255-day MA from below, it may mean that a fresh uptrend is about to begin. This is because the PVI is already above the 1-year MA.
Consider a scenario in which the PVI is down, but the NVI is increasing. This is often a bullish pattern. This signals that the less-informed investors are leaving and institutional and other "smart money" investors are taking control of the market. The two indicators clearly differ in this manner. Traders might plot a 100-day SMA to support a bullish entry to confirm this trend. During market downturns, a situation like this frequently occurs when "smart money" investors buy the dip while informal investors panic and liquidate their assets.
You should remember that the Positive Volume Index indicator should not be used to predict market movement on a daily or intraday basis. The PVI is a trustworthy indicator of a security's strength but cannot predict how much a security's price may increase. Additionally, the PVI is a lagging indicator. So it should not be employed in the technical analysis of penny stocks which are highly volatile and unpredictable.
Conclusion
The positive volume index (PVI) is an indicator that shows the relationship between trading volume and price changes. It measures volume as it increases from the previous trading day. The PVI indicates that institutional investors are entering the market in large volumes when price and volume rise. PVI is the opposite of the Negative Volume Index which indicates what the smart money (investments by institutional investors) is doing in a low volume. The PVI can also be combined with other indicators for a more comprehensive analysis of the market. However, it is also important to note that the PVI should not be used for daily prediction. Rather investors must use it cautiously, especially for highly volatile penny stocks.
