The direction of the moving average determines the direction of the envelopes. When the envelopes are moving higher, the price is in an uptrend. When the envelopes are moving lower, the price is in a downtrend. When the envelopes move sideways, the price is neither uptrend nor downtrend.
Center Band = n period SMA of the Source
Upper Band = Center Band x (1 + Envelope Percentage)
Lower Band = Center Band x (1 – Envelope Percentage)
How to Calculate Moving Average Envelopes
How to calculate a moving average envelope is pretty simple.
First, decide whether you want to use a simple moving average (SMA) or exponential moving average (EMA).
Remember, EMAs have less lag because they put more weight on recent prices.
Then, select the number of time periods you wish to apply.
Lastly, set the percentage value you’d like to use for the envelopes.
For example, a 10-day moving average with a 1% envelope would show the following lines:
Upper Envelope: 10-day SMA + (10-day SMA x .01)
10-day SMA
Lower Envelope: 10-day SMA – (10-day SMA x .01)
The chart below shows EUR/USD with a 10-day SMA and 1% envelopes.
Notice how the envelopes (blue lines) move parallel with the 10-day SMA (orange line).
They remain a constant 1% above and below the moving average (orange line).
How to Confirm Trend Direction with Moving Average Envelopes
Since the foundation of moving average envelopes (MAE) is the moving average, this means that the moving average envelopes can be used as a trend-following indicator.
The direction of the moving average determines the direction of the envelopes.
When the envelopes are moving higher, the price is in an uptrend.
When the envelopes are moving lower, the price is in a downtrend.
When the envelopes are moving sideways, the price is neither in an uptrend or downtrend. The trend is neutral and the price is considered directionless.
You should pay attention when the price moves above or below the envelopes.
Since trends often begin with a strong move, if the price surges above the upper envelope, this is considered bullish.
If the price plunges below the lower envelope, this is considered bearish.
Buy Signal
If the price closes above the UPPER envelope, buy.
Sell Signal
If the price closes below the LOWER envelope, sell.
Summary
Moving average envelopes (MAE) are used as a tool to confirm trend direction, but can also be used in sideways markets to identify overbought and oversold levels.
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