What Is the Envelopes Indicator?
The Envelopes indicator is classed as one of the momentum indicators used to mark overbought and oversold zones on a price chart. It is the simplest indicator built for that job. This article covers what the Envelopes indicator is and how to use it in trading. It helps to understand Standard Deviation Indicator.
What is the Envelopes indicator?
The Envelopes indicator is a momentum tool known as an envelope, or a shell built from moving averages. It is made up of two moving averages plotted on the price chart, and the space between these two lines defines a range the price moves inside. The idea behind the indicator is that price tends to stay within a set range under normal market conditions, and once those conditions change, price is able to move above or below the envelope’s bands.
Envelopes can be built from several types of moving averages, but the most common and widely used version is the moving average envelope.
Envelopes are commonly used to help traders and investors identify overbought and oversold conditions, as well as trading ranges.
How do you add the Envelopes indicator on MetaTrader?
It is genuinely simple. The indicator is already built into the MetaTrader platform, so there’s nothing to download or install — just follow the steps in the image below.
After that, the following window will appear.
In the window above you can change the Envelopes indicator’s settings. The first field controls the number of periods used to calculate the indicator’s value; the default setting is 14.
The second field is where you choose the type of moving average — exponential or simple. As you can see, the default setting is the simple moving average.
The third field is where you choose what price the moving averages are calculated from — candle closes, or highs and lows, and so on.
The fourth and final field is the most important one: the deviation value. Its default setting is 0.90, but this value doesn’t always match actual price movement — sometimes the bands sit too far away from price, as shown in the image below.
In the image above, the indicator’s deviation was left at its default value of 0.90, and you can see a wide gap between the indicator and price movement, which means a lot of missed opportunities. Because of that, we adjust the deviation value to match current price movement. There’s no fixed value here — you raise or lower it until you see the indicator lining up with how price is actually moving, as in the image below.
In the image above the indicator’s deviation was set to 0.50. Notice how much closer the moving averages sit to price movement, and how many more opportunities appear compared with the earlier image.
One thing to keep in mind when setting the indicator’s deviation value: a low reading can produce a lot of false signals because price crosses the moving averages too often, while a higher reading gives more accurate signals because there’s far less overlap between price and the moving averages.
How does the Envelopes indicator work?
There are several ways to use the Envelopes indicator, but what most traders focus on is using it to mark trading ranges. When price reaches the upper band, it’s considered overbought and a sell trade can be considered; when price reaches the lower band, it’s considered oversold and a buy trade can be considered.
The Envelopes indicator can suit traders who like trading bounces, since the core idea behind trading this indicator is that price tends to stay inside the defined range under normal conditions, and whenever it reaches one of those bands something unusual has happened — but price will return to where it was before.
Look at the image below.
In the image above, notice how price changed direction each time it reached one of the Envelopes indicator’s bands, bouncing back toward the other side. Price first bounced down, corrected back up, dropped again, then reversed higher again — showing that price reached an exhausted, overbought or oversold state near the indicator’s band each time.
Traders often use the Envelopes indicator with a wider setting to avoid false trading signals, although some pairs and timeframes call for different settings, especially pairs that are less volatile than others.
Of course, it’s best not to use the Envelopes indicator on its own — it should be combined with other strategies or indicators.
Let’s look at an example to see why. Look at the image below.
In the image above, notice that we combined the Envelopes indicator with support and resistance. In the first example, price rose past the indicator’s upper band; if we’d sold at that point we would have lost a lot of pips. Instead, we drew a descending channel over price movement and only sold after price bounced near that channel and closed back inside the indicator, which gave us strong entry points.
The same thing happened on the trade that followed: when price reached below the indicator’s lower band, buying as soon as price left the indicator would have lost the trade, or at least cost a lot of pips. Instead we waited for price to bounce off the lower support line and close above the lower moving average, which gave us strong entry points.
The same pattern repeated on the next trade.
Conclusion
The Envelopes indicator is a technical tool typically plotted on a price chart to show the upper and lower boundaries of price. Its most common form is the moving average envelope, built from two moving averages that mark the upper and lower price range levels.
The Envelopes indicator is used mainly to help traders and investors identify overbought and oversold zones as well as daily trading ranges. Here are the key points for using it well:
- The Envelopes indicator is a momentum tool known as an envelope, or a shell built from moving averages. It’s made up of two moving averages plotted on the price chart, and the space between them defines a range price moves inside.
- The default deviation setting is 0.90, but this value doesn’t always match actual price movement and the bands can sit too far from price. You can adjust this value to match price movement — there’s no fixed number, just raise or lower it until the indicator tracks price movement well.
- The idea behind this indicator is that price tends to stay within a set range under normal market conditions, and once conditions change, price can move above or below the envelope’s bands.
- One thing to keep in mind when setting the indicator’s deviation value: a low reading can produce a lot of false signals from excessive overlap between price and the moving averages, while a higher reading gives more accurate signals thanks to far less overlap between price and the moving averages.
- Of course, it’s best not to use the Envelopes indicator on its own — it should be combined with other strategies or indicators.
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Disclaimer: This article is for educational purposes only and does not constitute investment or trading advice. Trading CFDs and forex involves leverage and carries a high level of risk to your capital, and losses can exceed your initial deposit. Past indicator behavior does not guarantee future results. This page may contain affiliate links; if you open an account through one of them, easytradeweb.com may earn a commission at no extra cost to you.
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