Moving Average Envelope in Forex is the technical indicator consisting of two moving averages shifted up and down for a certain percentage. Deviation is measured from central moving average that can be put on chart. This indicator is mainly used to define borders of current price movement or as oversold/overbought indicator, when under the pressure of bears or bulls prices reach extremes. Also envelopes are good in showing market phase – under trend or flat. This figure is very similar to another equally well-know technical instrument Bollinger Bands, BB. The difference is just that envelopes use fixed values of percentage deviation, whereas in Bollinger bands deviation depends on volatility.
UPPER BAND — indicator's upper line;
LOWER BAND — indicator's bottom line;
SMA — simple moving average (can be experiential, smoothed, linear-weighted)
CLOSE — close price of previous period ;
N —period of averaging;
K / 1000 — (measured in tenth of per cents). The value of deviation from average (in one tenth in percent form)
While considering above formula, calculation method is not obvious at once. To put it simple, we can write as below:
K — Percent of shifting
Indicator's parameters are selected by a trader. You'll have to choose such shifting coefficient that the upper border of envelope will actuate as resistance for price and bottom border will act as support. Let's consider an example with following parameters: period – 10, shift – 0, MA method – Simple, apply to – Close, deviation – 1,68 % (Fibo proportion).
Pic. 1 – Moving Average Envelope
This way we have built certain borders, within which price moves. Breaking of one of borders will point at a high splash in activity, and price will strive to get back.
It is rather often, when on chart a number of envelopes of moving averages is put, but with a higher period. This building method provides us with certain advantages in trading.
Let's consider an example with 4 envelopes. Parameters: period – 55, shift – 0, MA method – Simple, apply to – Close, отклон deviation 0,68; 1; 1,68 % (Fibo proportion).
Pic. 2 – 4 Moving Average Envelopes
Looking at the chart, we can conclude about the following:
The steeper incline is, the stronger trend is. If lines are horizontal, flat movement prevails.
Median moving average, on the basis of which all the rest envelopes are drawn, acts as balance line. Under trend movements, such line will be good as dynamic support (on bullish market) or as resistance (on bearish market).
Rest envelopes serve for actuation of price and movement along dynamic levels. Under actuation of one of the levels, price either gets back to the previous one or moves to the next level.
Envelopes of moving averages are good in performing as dynamic support/resistance levels, and under certain periods – as overbought/oversold indicator. Among drawbacks one can note delays, which inherent to moving averages. The indicator can be used separately but more often it is recommended to filter signals with other technical instruments or, on the contrary, to use Envelopes as filter.
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