Envelopes technical indicator is formed with two Moving Averages, one of which is shifted upward and another one is shifted downward. The selection of optimum relative number of band margins shifting is determined with the market volatility: the higher the latter is, the stronger the shift is.
Envelopes define the upper and the lower margins of the price range. Signal to sell appears when the price reaches the upper margin of the band; signal to buy appears when the price reaches the lower margin.
The logic behind envelopes is that overzealous buyers and sellers push the price to the extremes (i.e., the upper and lower bands), at which point the prices often stabilize by moving to more realistic levels. This is similar to the interpretation of Bollinger Bands (BB).
Author: MetaQuotes Software Corp.
Moving Average Envelopes consist of a moving average plus and minus a certain
user defined percentage deviation. Moving Average Envelopes serve as an
indicator of overbought or oversold conditions, visual representations of price
trend, and an indicator of price breakouts. The inputs of the Moving Average
Envelopes indicator is shared below:
A chart of the Nasdaq 100 ETF (QQQQ) shows a 20-day moving average with both
a 1% and 2% percentage bands:
In the chart above of the QQQQ's, the price is not trending. During
non-trending phases of markets, Moving Average Envelopes make great overbought
and oversold indicators.
When stock prices are done resting and consolidating, they breakout, in one
direction or the other.
An illustration of an upward price breakout is shown above on the chart of
the QQQQ's. On the right side, the QQQQ's gapped up above the 2% price band.
A new trend in price is usually indicated by a price breakout as outlined
above with a continued price close above the upper band, for an upward price
trend. A continued price close below the lower band would indicate a new
downward price trend.
In the chart of the QQQQ's, after the price breakeout, the closing price
continued to close above the upper band; this is a good example of how a price
trend begins. Soon after, the price will fall back into the Moving Average
Envelopes, but the Moving Average Envelopes will be heading in a positive
direction - easily identifying the trend as up.
Moving Average Envelopes is a helpful technical analysis tool for identifying
trends and trend breakouts and identifying overbought and oversold conditions.
Other similar indicators such as Bollinger Bands and Keltner Channels that adjust to volatility
should be investigated as well.