Moving average envelopes are percentage-based envelopes set above and below a moving average. Envelopes can be deployed around any type of moving average. The upper and lower envelopes are typically set the same percentage above and below the moving average.
Upper Band = MA (CLOSE, P)* [ 1 + (K/100)]
Lower Band = MA (CLOSE, P)* [ 1 – (K/100)]
MA = Moving Average
P = Periods
K = Percentage change expressed as whole number percentage.
Trading with Moving Average Envelopes
Traders typically utilize envelopes to determine overbought and oversold levels when the price rises above the upper band or falls under the lower band. In these scenarios the trader would buy when the price rises through the lower band having fallen beneath it, and sell when the price falls through the upper band having previously risen above it. Some traders will modify the envelope settings to find momentum trades, buying when price crosses the upper band and selling when price crosses the lower band. Many traders use 2% envelopes for momentum trades, although preferences will vary. Setting the envelopes too high will generate loosing trades as the move may be near exhaustion, setting them too low may result in unprofitable over-trading.