MOVING AVERAGE ENVELOPES

Moving Average Envelopes are basically a pair of lines (trading bands) and sometimes also called as price envelopes, moving average bands or percentage envelopes. Basically moving average envelopes try to identify a range or band within which a stock is trading. Based upon a selected Moving Average and running in exactly the same pattern one of the envelope lines runs slightly above the moving average and the other envelope line runs slightly below the moving average, thus creating the the band which is also called as a trading band in between the two envelope lines. These envelopes deviate from the the moving average line by a user-specified percentage in order to determine when prices have strayed away from the moving average line by that percentage. For example, charting 4 % envelopes would display an upper parallel line that is 4 % above the MA line, and a lower parallel line that is 4 % below the MA line.

Calculation

First the simple or exponential moving average is derived. For more smoother curve the time period of Moving Average should be as large as possible. Thereafter the user specified % age is defined say 4 % ..this percentage is governed by the normal volatility of the stock. The formula thus to identify the lower and the upper band would be as follows

Top band = Moving Average + (Moving Average x 4 ÷ 100)

Applying the same percentage for the bottom band

Bottom band = Moving Average - (Moving Average x 4 ÷ 100)

Interpretation and use of Moving Average Envelopes

The moving average envelopes are good tool to identify oversold or overbought situation in a particular security. These are the reversal points of a particular security normally called bottom out or top out situation. Since the reversal in a security is normally not sharp and it takes little time to stay at those levels technical analysts opine that decision to buy or sell a security should be made after considering other technical indicators like stochastics.