The envelopes indicator is a handy tool that can be used with any trading instrument and timeframe, or utilized with the standard settings. Let’s explore it in a little more detail.
How does it work?
The envelopes indicator is a simplified version of the Bollinger Bands. It’s a combination of three Moving Averages (MA). It plots two of these on the up and downsides of the price, which then creates a channel that envelopes the price. The channel itself represents a normal trading range of security, whilst the two MAs function as the markers of the over-purchased/oversold levels. The middle Moving Average follows the trend of the chart.
In simple terms, the upper and lower lines act as support and resistance levels, allowing the trader to take advantage of the price reversal. The middle line displays the direction of the trend at that moment in time. An incline might mean an upward trend, whilst a decline might mean a downward trend. If the middle MA isn’t aiming towards any direction, it could be the sign of a flat market.
How can it be used in practice?
A buy signal is received when the middle MA is changing upwards.
A selling signal is observed when the middle MA is changing the direction downward.
In the case of a flat market, one may use the overbought and oversold levels as the reference point. Traders might adopt the upper and lower MAs to pinpoint reversals and breakouts.
In this example, several reversals are spotted when the price hits the upper or lower Moving Average and then bounces back, without breaking through the level. When it hits the upper or lower band, this means that it hit the extreme.
Like many other indicators, a divergence could occur and the indicator may show false signals, from time to time. You may want to combine the Envelopes Indicator with oscillators like RSI, to help you receive more accurate information.
How to set it up?
To set up this indicator, simply find it in the Moving Averages sections of the Indicators tab, as seen on IQ Option.
Once you select it, the settings menu will pop up. Here you can choose the period of the indicator, the deviation, the source (you may choose which value will be taken in the calculation – opening price, closing price, high, low etc.) and the type of the Moving Average.
The upper and lower levels are set in a way that means the price keeps within the borders for around 90% of the time. This allows the trader to change the deviation according to the volatility. The higher the volatility, the bigger the deviation.
The button “By default” can adjust the indicator to the default values. And that’s it, the indicator is ready to use!
The conclusion
The Envelopes indicator could be a great alternative to the simple Moving Averages and it can also provide the trader with a ready-to-go technical analysis system on its own. It could also be combined with other indicators. However, always keep in mind that there is no 100% guarantee that this indicator will not provide false information from time to time, too.
