The Envelopes indicator is a tool that serves to determine the upper and lower borders of the trading range. Two lines are displayed on the price activity chart, one of which, at a distance set by the trader, repeats the moving average above and the other below it.
Along with trading ranges, this technical analysis tool is usually used to identify extreme market conditions for overbought and oversold conditions.
How to use the Envelopes indicator
Traders interpret this tool differently. Many uses it to determine the trading range. When the price tests the upper limit, it is considered overbought, and a sell signal is formed. On the contrary, when the value overcomes the lower limit, the asset becomes oversold, which is an invitation to purchase. This rule is based on the law of alternation.
The upper and lower lines of the indicator are naturally determined in such a way that, under standard conditions, the price tends to remain within the range of Envelopes values.
When dealing with a volatile asset, investors using this tool can set a high rejection rate to avoid receiving signals too often. For less volatile assets, a more moderate setup will allow generating the necessary number of trading alerts.
To increase the likelihood of success, the Envelopes indicator is often deployed in conjunction with other forms of technical analysis.
For example, traders can identify possible moments when they enter the market when price spikes cross the boundaries of the indicator lines, while simultaneously observing trade volume indicators and market movement patterns to determine a possible pivot point.
This is the right approach, as financial assets are ultimately traded in oversold or overbought conditions for a long time.
Calculation Envelopes
The formula for calculating both components of the indicator is as follows:
- Top line = SMA (Close, T) * [1 + K / 100].
- Bottom line = SMA (Close, T) * [1-K / 100].
Here SMA is a simple moving average, Close is the closing price, T is the averaging period, K is the offset value from the average (measured in percent).
The main purpose of using the indicator is to identify changes in the trend.
In most cases, traders are faced with market movements strong enough to compensate for losses incurred by false signals. This suggests that Envelopes is indeed a useful tool for traders who want to accept a minimum percentage of winning trades.
Market participants must independently consider the volatility when changing settings.
It is also necessary to approach assets with low or high volatility in different ways, since narrower or wider ranges will be required to describe the price action by the Envelopes indicator.
Understanding Basic Signals
The trading indicator is based on the moving average, and we should expect that the internal characteristics of the latter will affect Envelopes.
A moving average is a common tool used to confirm the direction of movement of an asset, and is also used as a trend-oriented technical analysis tool.
Trending
A moving average is used to smooth out price fluctuations so that a trader can see a more general market model. If it rises, then this is a confirmation of the bullish mood. If it moves down, it confirms a bearish trend.
The same applies to the Envelopes indicator. A trader can look at his direction to get important information about market movement. If the band rises, then this indicates a bullish mood, and if it leans down, this confirms a bearish trend.
Better trading profitability can be achieved by combining Envelopes with CCI.
The indicator is also useful when searching for strong market movements, as a sign of the beginning of a powerful impulse.
When there is a strong downtrend, you can place signals about overbought to identify pullbacks and increase profit from rewards. The impulse becomes bearish again when the CCI indicator falls into negative territory.
As for Envelopes, if the price exceeds the upper limit, then this forms a signal about the beginning of a new trend. If the price, on the other hand, falls below the bottom line, this indicates the emergence of a downward trend. Caution should be exercised when such breakouts are observed, since most of them do not necessarily form a new trend. Often they return to their previous price range. But if a new trend arises in the development process, a change in the value of an asset can become dramatic.
Overbought and Oversold
The Envelopes indicator can be used to determine market conditions.
Assets become overbought or oversold and remain so during a strong uptrend or downtrend, respectively. To navigate in this situation, you need to monitor when the price breaks the upper line of the indicator and remains above it. This indicates a strong upward movement.
Indeed, the indicator maximum begins to grow after it is continuously exceeded by the value of the asset. Theoretically, this may indicate an overbought market, but also a signal that overbought conditions will persist.
The same is true for oversold conditions.
For example, the price enters the overbought territory when it breaks through the upper line of the indicator and if the CCI is also in this zone, then this is a sign that the value of the asset is also overvalued.
A U-turn occurs when the CCI line drops below 100, which confirms a sell signal.
Another scenario shows the price falling below the lower Envelopes border, which indicates overselling of the market. The CCI indicator also confirms this when its line does not exceed the level of -100. A break up confirms a pullback, i.e. a signal to open a long position.
Intraday Trading Strategies
Scalping (pipsing) with this technical analysis tool is possible using 1-, 5- and, possibly, 15-minute charts.
You need to configure the Envelopes indicator by setting a period of 40 and a deviation of 0.1, and apply it to one of the above timeframes. Experts advise to trade when breaking through the upper or lower border. If the price closes outside the range, and the previous candle does not, then this is a bearish or bullish signal, respectively.
Day trading strategies
Envelopes is difficult to use in day trading, but changing the settings can be of great help. Make sure that long time frames are set (hourly, 4-hour or one-day). The indicator must be set for a period of 28 with a deviation of 0.75 and to confirm the signals, add the percentage range of Williams.
A trading strategy with the Envelopes indicator of the breakout method is the most suitable and applies to day trading. It is to monitor when the price breaks the upper line, indicating the overbought market. If the percentage range of Williams becomes overbought (the aqua line is located above the -20 mark, and then falls below this level), it is considered that a sell signal is being formed.
Conversely, if the price breaks the border of the indicator minimum, oversold conditions are observed in the market.
You should wait until the Williams percentage range breaks through the oversold zone (-80.00) to form a buy signal.
Swing Trader Strategies
Swing trading is possible using the Envelopes indicator and it becomes even better when combined with other technical analysis tools (for example, stochastic) to help identify a rebound overbought or oversold.
It is necessary to set the period of this indicator to 10 and the deviation to 0.75, and the period of the stochastic indicator to 14. The overbought-oversold trading strategy is implemented on a 4-hour timeframe.
Binary Options Envelopes Indicator
An example of using the indicator in this type of trading is a channel breakout strategy. In the context of a binary option, the Envelopes indicator creates a price channel. The signal is formed when a candle and a 6-period exponential moving average breaks the channel up or down. The MACD indicator characterizes the strength of the movement towards the breakthrough. Its positive value confirms the signal to buy, and negative - to sell.
The timeframe is set at 5 minutes for 10, 15 and 30 minutes.
In conclusion
Envelopes is often used as an indicator of a trend, but also serves as a tool for determining the state of oversold or overbought market.
After a period of consolidation, a strong breakthrough of the indicator line may be the beginning of a protracted movement.
When a trader sees an uptrend, technical analysts may decide to use momentum indicators along with other systems to identify oversold areas and pullbacks held within such trends.
Overbought conditions along with rebounds can be the beginning of sales in a higher bear market.
If there is no strong trend, the indicator lines can function like a Williams percentage range oscillator.
Overcoming the upper barrier signals overbought, and the lower - warns of oversold.
To confirm these signals, it is extremely important to use other types of technical analysis.