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How to Use the Envelopes Indicator in Forex Trading

How to Use the Envelopes Indicator in Forex Trading

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The Envelopes indicator is a forex technical analysis tool used to detect changes in the volatility of a currency pair. Developed by a technical analyst and trader, George Lane in the 1950s, the Envelopes indicator consists of two moving averages, one of which points upward and the other pointing downward by a certain percentage. This article will teach you everything you need to know about the Moving Average Envelopes Indicator.

Moving Average Envelopes Indicator: Key Takeaways

There are several benefits to using the Envelopes indicator in forex trading, including: 

1. Identifying trend reversals: The Envelopes indicator can help traders identify potential trend reversals by identifying when the price of a currency pair breaks outside of the envelope. 

2. Setting stop-loss and take-profit levels: The Envelopes indicator can be used to set stop-loss and take-profit levels by using the upper and lower lines as resistance and support levels. 

3. Identifying overbought and oversold conditions: The Envelopes indicator can help traders identify when a currency pair is becoming overbought or oversold by identifying when the price breaks above or below the envelope. 

4. Confirming other technical signals: The Envelopes indicator can be used to confirm signals generated by other technical analysis tools, such as trend indicators, to provide a more robust and reliable trading strategy. 

5. Easy to use: The Envelopes indicator is a simple and easy-to-use technical analysis tool that can be easily integrated into any trading strategy. 

It's important to note that the Envelopes indicator should be used in conjunction with other technical analysis tools and fundamental analysis, to get a broader perspective of the market conditions. 

What Is a Moving Average Envelope? 

The Moving Average Envelope is a technical indicator that helps traders identify the upper and lower bands of a trading range. This is done by plotting two moving average envelopes on a price chart, one shifted above and one shifted below. When the market price breaks through these bands, we may attribute some significance to the move and trade accordingly. 

The Moving Average Envelopes serve as an excellent indicator for identifying trends, as well as identifying overbought and oversold conditions in the market. 

Forex Trading with Moving Average Envelopes Indicator
For instance, when the price breaks above the upper line, it can indicate that the currency pair is becoming overbought and that a potential sell opportunity may be present. Conversely, when the price breaks below the lower line, it can indicate that the currency pair is becoming oversold and that a potential buy opportunity may be present. 

The Moving Average Envelopes indicator was developed by George Lane in the 1950s. Lane was a technical analyst and trader who believed that the key to successful trading was to identify and follow trends. He developed the Moving Average Envelopes indicator as a way to detect changes in volatility and trend direction. Lane’s work in technical analysis and the development of the Moving Average Envelopes indicator has had a lasting impact on the field of technical analysis, and his ideas continue to be widely used by traders today.


How to Calculate Moving Average Envelopes Indicator? 

The Moving Average Envelopes Indicator works by placing bands above and below our instrument’s price level. As a starting point, we take a Moving Average (MA) of the price, which is usually a Simple Moving Average (SMA). This SMA is moved above the price in order to create an upper envelope, and below the price in order to create a lower envelope.  

The formula for the upper envelope is: 
Upper Envelope = SMA + (SMA x Percentage) 
The formula for the lower envelope is: 
Lower Envelope = SMA - (SMA x Percentage) 

Where SMA is the simple moving average and Percentage is the percentage deviation from the moving average that you want the envelopes to be. 

Calculating Moving Average Envelopes in Forex (example) 

Let’s say you are calculating the moving average envelopes for the EUR/USD currency pair and you want to use a 20-day moving average with a deviation of 3%. 

  1. First, calculate the 20-day simple moving average (SMA) of the EUR/USD currency pair. For example, let’s say the SMA is 1.2000. 
  1. Next, calculate the upper envelope by adding the SMA and the deviation percentage (3%) of the SMA. In this case: 1.2000 + (1.2000 x 3%) = 1.2000 + 0.036 = 1.2360 
  1. Calculate the lower envelope by subtracting the deviation percentage (3%) from the SMA In this case: 1.2000 – (1.2000 x 3%) = 1.2000 – 0.036 = 1.1640 

So, the upper envelope would be 1.2360 and the lower envelope would be 1.1640 for the EUR/USD currency pair with a 20-day moving average and a deviation of 3%. 

You can use this information to help identify potential buy and sell signals. If the currency pair's exchange rate moves above the upper envelope, it could be a signal to sell, while if the exchange rate moves below the lower envelope, it could be a signal to buy.

How to Confirm Trend Direction with Envelopes Indicator 

Taking into account that Moving Average Envelopes (MAE) are built on a moving average, Moving Average Envelopes can be considered trend-following indicators.  

The envelopes indicator usually confirms the direction of a trend by examining the relationship between an exchange rate and its upper and lower envelopes. 

  • If the exchange rate is consistently above the upper envelope, it can be considered a bullish signal and confirms an uptrend
  • Conversely, if the exchange rate is consistently below the lower envelope, it can be considered a bearish signal and confirms a downtrend
  • When the exchange rate is between the upper and lower envelopes, it is considered a non-trending market or a ranging market. 

Trends usually begin with a strong move, so if the price rises above the upper envelope, it is considered bullish. And prices that plunge below the lower envelope are considered bearish.


How to find ‘Buy’ and ‘Sell’ signals using Envelopes Indicator 

The moving average envelopes indicator can be used to identify potential buy and sell signals by looking at the relationship between the exchange rate and the upper and lower envelopes. 

Envelopes Indicator Forex Education

Buy Signal: 

  • If the exchange rate moves below the lower envelope, it can be considered a buy signal as it suggests that the security has been oversold and is likely to rebound. 
  • If the exchange rate crosses above the lower envelope after being below it, it can also be considered a buy signal as it suggests that the security is starting to rebound. 

Sell Signal: 

  • If the exchange rate moves above the upper envelope, it can be considered a sell signal as it suggests that the security has been overbought and is likely to fall. 
  • If the exchange rate crosses below the upper envelope after being above it, it can also be considered a sell signal as it suggests that the security is starting to fall. 

It’s important to note that these signals are not always accurate, and there can be false signals or whipsaws. Additionally, it’s important to use other technical indicators, such as volume and momentum indicators, to confirm these signals. It’s also important to consider the overall market conditions and any fundamental factors that may be affecting the trading instrument.


How to Identify Overbought & Oversold Levels with Envelopes 

When the market is range-bound, and the moving average slope is FLAT, the Envelopes Indicator can also be used to indicate when a financial instrument is oversold or overbought.   

Envelopes Indicator Forex Education

Overbought Level: 

When the exchange rate moves above the upper envelope, it can be considered an overbought level, as it suggests that the security has been bought excessively and is likely to fall. 

Oversold Level: 

When the exchange rate moves below the lower envelope, it can be considered an oversold level, as it suggests that the security has been sold excessively and is likely to rebound. 

It's also important to keep in mind that sometimes the percentage deviation used to create the upper and lower envelopes will affect the overbought and oversold levels. A lower deviation will give you a tighter range, and the security will be considered overbought or oversold at a higher price, a higher deviation will give you a wider range, and the security will be considered overbought or oversold at a lower price.

How to Use the Envelopes Indicator in MetaTrader 

Envelopes are one of the standard trading indicators that come as part of the core tools embedded with both MetaTrader 4 (MT4) and MetaTrader 5 (MT5) platforms. 

To use the Envelopes indicator in MetaTrader, follow these steps: 

  1. Open the MetaTrader platform and open a chart for the market you wish to analyze. 
  1. Click on the “Insert” menu at the top of the screen and select “Indicators.” 
  1. Scroll down to the “Trend” category and select “Envelopes.” 
  1. A new window will appear with several options for configuring the indicator. You can set the moving average type, the period, and the deviation percentage for the upper and lower lines. 
  1. Once you have set the options, click “OK” to apply the indicator to the chart. The upper and lower lines will be plotted on the chart, and you can use them to identify potential overbought and oversold conditions. 
  1. As you can see the upper line is above the price and the lower line is below the price when the price crosses the upper line, that’s a sell signal and when the price crosses the lower line, that’s a buy signal. 

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Best Envelopes Indicator Combinations for Forex Trading  

Forex Trading with Envelopes Indicator

There are several indicators that can be used in combination with the Envelopes indicator to enhance the accuracy of trading signals and to confirm market trends. Here are a few examples: 

  1. Moving Averages: Moving averages can be used to confirm the direction of the trend. When the price is above the moving average, it indicates an uptrend and when the price is below the moving average, it indicates a downtrend. 
  1. Stochastic Oscillator: The Stochastic Oscillator is another momentum indicator that can be used to confirm overbought and oversold conditions. When the Stochastic is above 80, it indicates an overbought market, and when it is below 20, it indicates an oversold market. 
  1. Relative Strength Index (RSI): RSI is a momentum indicator that can be used to confirm overbought and oversold conditions. When the RSI is above 70, it indicates an overbought market, and when it is below 30, it indicates an oversold market. 
  1. Bollinger Bands: Bollinger Bands are a volatility indicator that can be used to confirm breakouts. When the price breaks above the upper Bollinger Band, it indicates a bullish breakout, and when the price breaks below the lower Bollinger Band, it indicates a bearish breakout. 
  1. Volume: Volume can be used to confirm trends and breakouts. When the volume is increasing during an uptrend, it confirms the trend, and when the volume is decreasing during a downtrend, it indicates a potential reversal. 
  1. MACD: Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that helps to identify momentum and trend direction. 

It’s important to note that these indicators should be used in conjunction with each other and with price action analysis for a more comprehensive analysis. Additionally, it’s important to test different indicators and combinations to see which ones work best in different market conditions and for your trading style.


Moving Average Envelopes: Easy-to-Use Forex Strategies

Envelopes Indicator Forex Education

There are several trading strategies that can be used with the Envelopes indicator in Forex trading. Here are a few examples: 

1. Trend Following Strategy 

Trend following is a popular forex trading strategy based on closely observing existing trends and following them in an attempt to gain profits. The strategy is based on the assumption that a strong trend is in place when the price is above the upper Envelopes line or below the lower Envelopes line. 

For instance, if the asset remains between the upper and middle lines of the envelopes, it will remain in an uptrend. Likewise, as long as it remains between the lower and middle lines in a downtrend, it will continue in that direction. It is good to ‘Buy’ when the price is above the upper Envelopes line and the trend is up and ‘Sell’ when the price is below the lower Envelopes line and the trend is down. 

2. Divergence Strategy 

This approach is often more comfortable for trend followers. Finding reversals using the Envelopes indicator can be done by identifying divergences between the indicator and the price action of the market. A divergence occurs when the price and the indicator move in opposite directions. This can be a sign that the current trend is losing momentum and that a reversal may be imminent. 

When the price makes a new high or low and the Envelopes indicator does not, it can indicate a potential reversal. A bearish divergence occurs when the price makes a higher high and the Envelopes indicator makes a lower high, indicating a potential bearish reversal. A bullish divergence occurs when the price makes a lower low and the Envelopes indicator makes a higher low, indicating a potential bullish reversal. 

3. Overbought/Oversold Strategy 

An overbought/oversold strategy using the Envelopes indicator involves buying when the price dips below the lower Envelopes line and selling when the price rises above the upper Envelopes line. This strategy is based on the assumption that the market is overbought when the price is above the upper Envelopes line and oversold when the price is below the lower Envelopes line. 

Identify the current trend in the market by looking at the position of the price relative to the Envelopes lines. ‘Buy’ when the price dips below the lower Envelope line and the trend is down, and ‘Sell’ when the price rises above the upper Envelope line and the trend is up. Place stop-loss orders to protect yourself from significant losses in case the trend changes. 

4. Breakout Strategy 

A breakout strategy using the Envelopes indicator involves identifying when the price breaks above the upper Envelopes line or below the lower Envelopes line, which can indicate a strong trend in the market. This strategy is based on the assumption that a breakout above or below the Envelopes lines signals a strong trend in the market. 

Look for the price to break above the upper Envelopes line or below the lower Envelopes line. Once a breakout is identified, use a stop-loss order to protect yourself from significant losses in case the breakout is false. If a bullish breakout occurs, place a buy order and set a target profit at a key resistance level. If a bearish breakout occurs, place a sell order and set a target profit at a key support level. 

5. Mean Reversion Strategy 

A mean reversion strategy using the Envelopes indicator involves buying when the price is below the lower Envelopes line and selling when the price is above the upper Envelopes line. This strategy is based on the assumption that the market will eventually revert to its mean, or average, price level. 

Identify the current trend in the market by looking at the position of the price relative to the Envelopes lines. ‘Buy’ when the price is below the lower Envelopes line and ‘Sell’ when the price is above the upper Envelopes line. Use a profit target that is based on the historical mean of the asset or use a trailing stop loss order to lock in profits as the price moves back towards the mean.


Limitations of using Moving Average Envelopes Indicator: 

The Moving Average Envelopes indicator has several limitations that traders should be aware of when using it for technical analysis: 

  1. Delayed Signals: The Envelopes indicator is based on a moving average, which is a lagging indicator. This means that it can provide signals that are delayed compared to the actual price movements. 
  1. False Signals: The Envelopes indicator can generate false signals, particularly during choppy or sideways market conditions. This can result in unnecessary losses if the trader acts on these false signals. 
  1. Limited applicability: The Envelopes indicator may not be suitable for all markets or timeframes. For example, it may not work well in markets with high volatility or in short-term trading. 
  1. Reliance on deviation percentage: The Envelopes indicator relies on the deviation percentage set by the trader, which can affect the accuracy of the signals. It’s important to use a deviation percentage that is appropriate for the market and the timeframe being analyzed. 
  1. Not good for identifying market tops or bottoms: Envelopes indicator is not good at identifying market tops or bottoms. It is better suited for identifying overbought and oversold conditions. 
  1. Not good for identifying trend changes: Envelopes indicator is not good at identifying trend changes. It is better suited for identifying short-term trends. 

Make sure your trading decisions should not be based solely on the Envelopes indicator, but rather on a combination of technical analysis tools, fundamental analysis, and market analysis as well. Furthermore, you should monitor the market conditions continuously and adjust your strategy accordingly to stay profitable.


Moving Average Envelopes Indicator – FAQ 

What are Envelopes indicators? 

Envelopes indicators are a type of technical analysis tool that is used to identify potential overbought and oversold conditions in the market, as well as to confirm the direction of the trend. This indicator predicts that the market will eventually revert to its average price level and any prices that remain above or below the upper or lower envelope lines may indicate an overbought or oversold market. 

How do you read a moving average envelope indicator?

Identify the current trend by looking at the position of the price relative to the upper and lower lines of the indicator. When the price is above the upper line, it indicates an uptrend, and when the price is below the lower line, it indicates a downtrend. When the envelope is between the upper and lower envelopes, you’re dealing with a non-trending market or a ranging market. 

How do you use an envelope indicator in forex? 

The Envelopes indicator can be used in Forex trading to identify potential overbought and oversold conditions and to confirm the direction of the trend. Look for the price to be consistently above or below the upper or lower Envelopes line, which indicates a strong trend in the market. Look for the price to break above or below the upper or lower Envelope line, which indicates the market is overbought or oversold. 

How do you calculate the moving average envelope?

To calculate the Moving Average Envelope, take a moving average of the price, set a deviation percentage, and then add and subtract the deviation percentage from the moving average to create upper and lower lines. Plot these lines on the chart along with the moving average line. Make sure the deviation percentage remains appropriate to the asset and the timeframe being analyzed.

What is the best deviation percentage for the Envelopes indicator?

The best deviation percentage to use with the Envelopes indicator in Forex trading will vary depending on the currency pair and the timeframe being analyzed. A common setting is 2%, but it’s important to test different deviation percentages to see which one works best for your trading style and the specific market conditions. 


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