Forex Indicator MT4

# Envelopes

What is Envelopes indicator, the instructions of Envelopes and how to use the Envelopes indicator, the calculation of Envelopes indicator and the Envelopes indicator main parameters

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## Introduction

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.

Envelopes are percentage-based envelopes set above and below a moving average. The moving average, which forms the base for this indicator, can be a simple or exponential moving average. Each envelope is then set the same percentage above or below the moving average. This creates parallel bands that follow price action. With a moving average as the base, Moving Average Envelopes can be used as a trend following indicator. However, this indicator is not limited to just trend following. The envelopes can also be used to identify overbought and oversold levels when the trend is relatively flat.

## Calculation

`Upper Band = SMA(CLOSE, N)*[1+K/1000]Lower Band = SMA(CLOSE, N)*[1-K/1000]`

Where:

• SMA — Simple Moving Average;
• N — averaging period;
• K/1000 — the value of shifting from the average (measured in basis points).

## Interpretation

Indicators based on channels, bands and envelopes are designed to encompass most price action. Therefore, moves above or below the envelopes warrant attention. Trends often start with strong moves in one direction or another. A surge above the upper envelope shows extraordinary strength, while a plunge below the lower envelope shows extraordinary weakness. Such strong moves can signal the end of one trend and the beginning of another.

With a moving average as its foundation, Moving Average Envelopes are a natural trend following indicator. As with moving averages, the envelopes will lag price action. The direction of the moving average dictates the direction of the channel. In general, a downtrend is present when the channel moves lower, while an uptrend exists when the channel moves higher. The trend is flat when the channel moves sideways.

Sometimes a strong trend does not take hold after an envelope break and prices move into a trading range. Such trading ranges are marked by a relatively flat moving average. The envelopes can then be used to identify overbought and oversold levels for trading purposes. A move above the upper envelope denotes an overbought situation, while a move below the lower envelope marks an oversold condition.

## Trend Identification

Moving Average Envelopes can be used to identify strong moves that signal the start of an extended trend. The trick, as always, is picking the correct parameters. This takes practice, trial and error.

## Overbought/Oversold

Measuring overbought and oversold conditions is tricky. Securities can become overbought and remain overbought in a strong uptrend. Similarly, securities can become oversold and remain oversold in a strong downtrend. In a strong uptrend, prices often move above the upper envelope and continue above this line. In fact, the upper envelope will rise as price continues above the upper envelope. This may seem technically overbought, but it is a sign of strength to remain overbought. The reverse is true for oversold. Overbought and oversold readings are best used when the trend flattens.

Overbought and oversold conditions should serve as alerts for further analysis. Overbought levels should be confirmed with chart resistance. Chartists can also look for bearish patterns to reinforce reversal potential at overbought levels. Similarly, oversold levels should be confirmed with chart support. Chartist can also look for bullish patterns to reinforce reversal potential at oversold levels.

## Conclusions

Moving Average Envelopes are mostly used as a trend following indicator, but can also be used to identify overbought and oversold conditions. After a consolidation period, a strong envelope break can signal the start of an extended trend. Once an uptrend is identified, chartists can turn to momentum indicators and other techniques to identify oversold readers and pullbacks within that trend. Overbought conditions and bounces can be used as selling opportunities within a bigger downtrend. In the absence of strong trend, the Envelopes can be used like the Percent Price Oscillator. Moves above the upper envelope signal overbought readings, while moves below the lower envelope signal oversold readings. It is also important to incorporate other aspects of technical analysis to confirm overbought and oversold reading. Resistance and bearish reversals patterns can be used to corroborate overbought readings. Support and bullish reversal patterns can be used to affirm oversold conditions.

## Main Parameters

The parameters for the Moving Average Envelopes depend on your trading/investing objectives and the characteristics of the security involved. Traders will likely use shorter (faster) moving averages and relatively tight envelopes. Investors will likely prefer longer (slower) moving averages with wider envelopes.

• Mode:
• Upper Line: Upper Band
• Lower Line: Lower Band
• Period: Averaging period for calculation of the main line, default is 14
• MA method:
• Simple
• Exponential
• Smoothed
• Linear weighted
• Deviation: Percent deviation from the main line, default is 0.1
• Shift: MA shift. Indicator line offset relate to the chart by timeframe, default is 0
• Apply to: Applied price
• Close
• Open
• High
• Low
• Median Price, (high+low)/2
• Typical Price, (high+low+close)/3
• Weighted Close, (high+low+close+close)/4