Envelopes

Definition:

The Envelopes technical indicator is formed by using two moving averages where one of them is shifted up by a certain percentage or amount, and the other is shifted down by that same amount or percent. This forms a pair of parallel lines that usually surrounds the price action when suitable parameters are chosen for the indicator.

When choosing Envelope indicator parameters, traders tend to use wider bands with markets that generally have a higher volatility level, and narrower bands with lower volatility markets. Also, Envelopes can either be centered on the price action itself, or on another moving average. The moving averages chosen for the Envelope can also vary, with simple, exponential and weighted moving averages all in common usage.

The idea behind using Envelopes to trade stems from the observation that markets tend to trade to extremes as enthusiastic buyers or sellers fail to see the signs of a price reversal. The market often subsequently corrects to more sustainable levels. Like the Bollinger Band Indicator, Envelopes can provide traders with a sense of when the market may be due for correction.

Sample Chart:

Usage:

In general, Envelopes act like the Bollinger Band indicator in that they give theoretical upper and lower boundaries for the market price action to trade between.

The Envelopes indicator generates a sell signal when the market reaches the Upper Envelope line. Conversely, a buy signal is generated when the market touches the Lower Envelope line.

Calculation Method:

Define:

• n= the number of the time period bar in question.
• N= the number of periods in the smoothing average.
• Close(n)= The closing price at the end of time period n.
• K= The Value of the shift in basis points.
• SMA(A,B)= Simple Moving Average of data item A over B periods.

Calculate:

• Upper Envelope = SMA(Close(n), N)*[1+K/1000]
• Lower Envelope = SMA(Close(n), N)*[1-K/1000]

Practice Envelopes Trading

Technical analysis with Envelopes is a demanding skill that requires practice to master. We recommend that you use a demo account to train yourself for free before applying your skills to real money trading.
Most reputale trading platforms today (for example: GFC Trader, AVA Trader, Meta Trader) feature technical indicator functions which can be applied on real-time charts. You can open a free account, download the trading software and start sharpening your technical analysis skills today!

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