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Hunting Key Levels with the Envelopes Indicator

Envelopes.jpg

The Envelopes indicator is a tool that attempts to identify the upper and lower bands of a trading range. It does this by plotting two moving average envelopes on a price chart, one shifted up a certain distance above and one shifted below.

If the market price breaks through these bands, we may assign some significance to the move and trade accordingly. We'll talk in detail about this later on in the article, but let's first look at how we calculate the levels of these trading envelopes.

Calculating the Level of the Trade Envelopes

As we said in the preamble, the indicator works by placing trading bands above and below the price level of our instrument of choice. The basic methodology is to first take a moving average (MA) of the price. Often, this is a Simple Moving Average (SMA). We create our upper envelope by shifting this SMA a certain distance above the price. Similarly, we create our lower envelope by shifting the SMA the same distance below the price.

The precise calculation method is given by the two equations below:

  1. upper envelope = SMAN