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Envelopes or channel lines are set parallel to the Moving Average (to the slow MA if you use two MAs). The two channel lines must contain approximately 95% of all prices for the past two or three months on a daily chart, with only the extremes protruding outside. Channel lines provide attractive profit targets - sell longs near the upper line and cover shorts near the lower line.
The AutoEnvelope is a custom indicator - an original tool that automatically selects channels width by calculating a standard deviation for the last 100 bars. It is designed to either use a fixed channel size or to change value at most once a week (once a month on a weekly chart), making it suitable even for intra-day data (use the "Fixed channel size" parameter to switch from one mode to the other).
The EMA is plotted in addition to the AutoEnvelope. This combination allows you to change the EMA and have the envelope follow it without adjusting two separate indicators. If you do not want to see the moving average, go into the AutoEnvelope properties and change color of the average (2nd line) to "None".
- EMA_Length (22) – This is the number of bars for the Exponential Moving Average plotted in the center of the channel.
- Factor (27) – This is the number of standard deviations (expressed in the tenths) for creating the channel. Statistically, 2.7 is the proper size to use, but that assumes a standard distribution, which is not always present in the markets. We found that 27 works for most stocks using daily data, but you may want to adjust this Factor to fit your trading vehicle and style.
- Fixed_Channel_Size (true) – Channel can be either fixed or dynamic. If fixed size is ticked, channel corresponds to the channel size at the right edge. Otherwise, channel size is changing once a week.
New version 2.0
- "Fixed channel size" parameter is deprecated and replaced by "Channel_Mode" parameter.
- AutoEnvelope short name indicates the selected mode
Possible values for "Channel_Mode" parameter are:
- Fixed channel size, to use the right edge channel width (corresponds to the true value of the version 1.0 "Fixed channel size" parameter).
- Weekly sized channel, to compute the channel width once per week (corresponds to false value of the version 1.0 "Fixed channel size" parameter).
- Dynamic channel size, to compute the channel width at each bar.