Technical indicator

Envelopes

Envelopes are two moving averages shifted a fixed percentage above and below the price average. They mark the boundaries of a security’s normal trading range.

Type

Trend / trading range

Typical parameters

n = 20 days, P = 2.5–10%

Main signal

Price reaching or crossing the upper (sell) or lower (buy) band

The idea behind Envelopes

The logic of the Envelopes indicator is that over-eager buyers and sellers push the price to the extremes of its normal trading range, after which the price tends to return toward the average. Envelopes are similar to Bollinger Bands, but the band width is a fixed percentage rather than a multiple of volatility, so the bands keep a constant relative distance from the average.

Calculation

where MA_n is an n-day moving average of the closing price and P is the percentage shift. Choose P so that most prices of the past few months stay inside the bands; volatile stocks need wider envelopes.

Trading signals

• Sell when the price rises to or above the upper band – the security is extended to the upside.
• Buy when the price falls to the lower band and then turns back up through it.
• In a strong trend the price can ride along one band for a long time; treat closes outside a band in the direction of the trend as confirmation rather than a reversal.