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Envelopes

Posted in Indicators of technical analysis

Envelopes are an easy indicator to use. It consists of two moving averages, or we can also say of two variations of one moving average.

Its calculation is as follows:

 

Upper envelope = EMAx  + y %

Lower envelope = EMAx – y %

EMAx = selected moving average
y % = optional percentage of Envelope width

 

Both - Upper and Lower Enverope do copy the moving average in the distance the trader chosed. E.g. if EMA21 was 10 poinst and the optional percentage of Envelopes width is 5 %, then the upper Envelope would be 10.5 and lower Envelope 9.5 points.

 

Envelopes

Copyright © Picture made by Incredible charts

 

How to use the Envelopes:

The basic idea that stands behind this indicator is that prices use to oscillate in a close range around their moving average (so they move in "Envelopes"). If the price crosses its envelopes, it tends to return back to the "normal values". So, as you maybe realized, we go Short when the price crosses its upper Envelope upwards. We go Long when the price crosses its lower Envelope downwards. In other words we expect the price to fall or rise allways to its moving average. This is true especially when there isn't any strong trend prevailing and the market is a kind of choppy.

Should the market be trending, the price doesn't move in whole of the Envelope's range. In such case it mostly moves either in the upper range (from the EMA to the Upper Envelope) - if there is an Uptrend, or in the lower range (from the Lower Envelope to the EMA) - if the Downtrend prevails. In such case, should the price fall down from its Upper Envelope to its EMA, we buy (that is for the Uptrend). Should the price rise up from the Lower Envelope to its EMA, we go Short.


MA Envelopes are quite similar to Bollinger Bands. The difference is that BB take into consideration the market volatility, but the price Envelopes are allways in the same range from the Moving average. The market volatility is not taken into consideration during their construction. That is the reason why it's quite appropriate to modify the Envelopes width during higher market volatility.

There isn't any definite recommendation for the EMA period and its Envelopes width settings. Every market has its own  uniques, volatility and if you decide to base your trades upon Envelopes, you should made some historical tests. You must find out  which combination of moving averages and Envelopes width would suite you best and would be profitable enough.  But maybe there is one good recommendation for the traders: Try to adapt the Envelopes in such way so at least 90 % of all the values would move inside the Envelopes and just 10 % max. would exceed either Upper or Lower Envelope.

If you are interested in a deeper study of this technical indicator and prefer ready to serve solutions, this section may be of  interest to you. There you can find all the available indicators in Excel file for download.


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