The envelope indicator is a tool used in determining periods when security is overbought or oversold. This is achieved by plotting the indicators over a price chart that has a lower and upper border of a trading range. The indicator applies the idea that prices tend to remain in a particular range under normal market circumstances. In case these prices change below over the envelope indicators, it signals a possible trading position.
Features of envelope indicator
• Lower band/ envelope
• Upper band/ envelope
• Chart patterns / volume metrics
Calculations of the envelope indicator
The indicator uses envelope bands which are calculated by use of moving averages. The simple moving average defines the upper and lower boundaries. Following is the formula. (Try out indicators on Tradingview.com)
Upper band/ envelope = SMAN + (SMAN x D%)
Lower band/ envelope = SMAN – (SMAN x D%)
• SMA represents the simple moving average
• N represents the number of used periods for moving average
• D represents the deviation value from the moving average
Interpretation of Envelope indicator
Whether your trading goals are short term or long term, Envelope can effectively guide you in decision-making. When the asset price crosses the upper boundary, it may indicate it is the time to sell. As a trader, you can sell a security at a price above the upper limit and close the trade when the prices fall to the trading range. On the other hand, traders may buy securities when prices fall below the lower Envelope and terminate the trade when the prices get to the normal range.
• Overbought conditions are achieved when the prices hit the upper band of the indicator indicating a potential sell signal.
• Oversold conditions are achieved when prices hit the lower Envelope indicating a potential buy signal
How Envelope indicator is used
• Trend confirmation. The indicator is used to determine the trend of a security as the market trends
• Overbought and oversold securities. The indicator is useful in determining the oversold and overbought financial instruments.
Key Takeaways
• The envelope signals (upper and lower bands) are generated using a simple average and a predetermined range over and under the moving average.
• Reaction to sell or buy by a trader is triggered when the price crosses the upper or the lower band.
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