Welcome, everybody. Financial markets always attract the
interest of millions of people worldwide. These markets include stocks,
currency pairs, commodities, and many other financial instruments. While these
markets are full of opportunities, one must not overlook the risks. To succeed
in the financial markets, the ability to forecast market movements is
indispensable. For this purpose, we need to combine technical and fundamental
analysis. Fundamental analysis is an investment tool that uses economic, financial,
and sectoral data to determine the true value of an asset. It is particularly
important for long-term investors because market prices are more likely to move
based on fundamental factors. Financial markets are often characterized by fast
and complex price movements. Understanding these movements and making the right
decisions is very important for our
success. This is where technical analysis tools and indicators come into play.
The Envelope indicator is one of these indicators. In this article, we aim to
explain the basics and usage of the Envelope indicator, providing an understanding
of how to interpret this indicator.
What is the Envelopes indicator?
The Envelope indicator is a type of oscillator in technical
analysis. It measures how price movements change between bands and indicates
how close the market is to overbought or oversold conditions. This indicator is
used to track the price movements of a financial instrument and to determine
possible support and resistance levels. Besides that, the Envelope indicator
helps identify points where market prices have peaked at overbought and
oversold levels and are likely to reverse. The Envelope indicator draws
boundaries around price movements, signaling probable points where market
trends may change direction. In other words, it provides signals used to
identify price retracements and probable trend reversals.
Components and calculation of the Envelope indicator?
The Envelope indicator measures the deviation of prices from
a moving average. To visualize these deviations, the Envelope indicator draws
two lines or bands around the moving average:
1. Upper Band: The upper band is typically a line that
represents price movements being a certain percentage above a moving average.
For instance, if we are using a 5% upper band, it means the line will be
located 5% above the moving average. The Envelope indicator has a simple
formula to calculate the Upper Band:
Upper Band = Moving Average + (Moving Average x Chosen
Percentage)
2. Lower Band: The lower band represents price
movements being a certain percentage below a moving average, just like the
upper band. The same percentage is used for both upper and lower bands. The
formula is as follows:
Lower Band = Moving Average - (Moving Average x Chosen
Percentage)
In this context, the Upper Band represents the upper
boundary of the Envelopes indicator. The Moving Average is usually
calculated as the average of closing prices over the chosen period. The Chosen
Percentage determines how far apart the upper and lower bands will be from
the moving average. For example, if we use 5%, it indicates that the upper and
lower bands will be 5% away from the moving average.
In the chart below, with a 20-day moving average and a
chosen percentage of 5%, the formula will be as follows:
- Upper Band = 20-Day MA + (20-Day MA x 0.05)
- Lower Band = 20-Day MA - (20-Day MA x 0.05)
The Envelope indicator illustrates that prices move within a
specific range around the moving average. This information enables us to
analyze price movements and create our own trading strategies.
Trading with the Envelope indicator
The Envelope indicator is a technical analysis tool based on
Moving Averages (MA). This indicator is used to track price movements in
financial markets and identify trends. Like other Moving Averages, the Envelope
indicator has specific characteristics and applications. Firstly, the slope of
the indicator lines indicates the direction of a trend. If the Envelope bands
slope upward, it can signal an uptrend. Conversely, if the bands slope
downward, it indicates a downtrend. These slopes help us define the market
trend. When the market is in a specific range, price increases above the upper
Envelope band suggest that the asset is overbought and likely to reverse. On
the contrary, movements below the lower band indicate that the market is
oversold, and the price may reverse. In these situations, we can consider
entering trades to capture reversals. In the first scenario, we might enter a
Sell order, and in the second, a Buy order. Take a look at the example on the
weekly AUD/NZD chart below:
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| Trading with Envelope Indicator on AUD/NZD chart |
The envelope bands create a channel where the price moves.
It's recommended to buy when the price reaches the lower band during an uptrend
and to sell when the price reaches the upper band during a downtrend. These
trades are made with the expectation that the trend will continue. The lower
and upper bands act as support and resistance levels.
Remember. In the world of trading, risk management is a
critical component of any trading strategy. While it's important to predict
market movements and generate trading signals using indicators like the
Envelope indicator or other analysis tools, it's not possible to guarantee the
success of every trade based on these signals. Every trading decision involves
risk. Therefore, even when using the Envelope indicator or other analysis
tools, it's essential to develop strategies for managing risk to minimize probable
losses. Best of luck in your trading!