The Envelope is a technical indicator developed by John Bollinger. It is typically plotted over a price chart with the lower and upper bounds. The most common type of envelope indicator is a moving average envelope, which is created by pairing the two moving averages. The Moving average envelopes are percentage-based, and they follow the trend. Envelopes are commonly used to identify the overbought and oversold conditions in the market.
When the currency hits the upper bound, the asset is said to be in an overbought, and a downside reversal is expected. Conversely, when the prices hit the lower bound, the asset is said to be in an oversold condition, and an upside reversal is expected.
Envelopes work really well in a ranging market. But during the less volatile state, the prices tend to stay within the upper and lower bound. When the trend is super strong or volatile, traders may use the higher percentage (can be changed in the settings) to avoid the whipsaws. Likewise, traders use the less percentage in a less volatile market, to generate more trading signals. Envelopes are commonly used in tandem with other indicators, price action, candlestick patterns for extra confirmation.
Center Band = n period SMA of the Source
Upper Band = Center Band x (1 + Envelope Percentage)
Lower Band = Center Band x (1 – Envelope Percentage)
Installing Envelope in MT4 (Step-by-step process)
By default, the Envelope indicator is available in the MT4 Terminal.
Open the MT4 Terminal.
Click on Insert > Indicators > Trend > Envelopes.
In the below chart, we have applied the envelope indicator on to the AUDUSD chart.
Envelope Indicator – Trading Strategies
Envelope + RSI Indicator
As we have already discussed, Envelopes work best in a ranging market. Hence in this strategy, we have paired the Envelope indicator with the RSI indicator to trade the ranges.
RSI (Relative Strength Index) is a momentum indicator which measures the magnitude of price change to find out the overbought and oversold conditions in the market. The Indicator consists of a line graph that moves between the two extremes areas and has a reading from 0 to 100 levels. RSI oscillates between traditional levels of 70 and 30. The market is considered to be oversold when RSI reaches below 30 and is considered overbought when RSI reaches above 70 levels.
The strategy is as follows: In a ranging market, when the RSI reaches the oversold area and gives a sharp reversal, see if the price hits the upper bound. If yes, it is a sell signal for us. Do not hit the sell when the price hits the upper bound, wait for one or two red candles for confirmation to take the trade. Conversely, when the prices hit the lower bound in a range, it is a buy signal to take the trade.
In a sideways market, prices are quite volatile. We suggest you to put the stop-loss a bit spacious to the range in order to avoid the whipsaws. If the price breaks the range and immediately comes back in and holds within the range, you can place the stop-loss order just above the recent high.
As you can see in the image below, Envelope and RSI gave us three trades within a range, and every trade performed well.
Envelopes + Bollinger Bands
In this strategy, we have paired the Envelopes with the Bollinger bands to identify the buy/sell signals. There are many similarities between the Envelopes and Bollinger Bands. Bollinger bands also consist of two bands above and below the price; it consists of the centre line, which is the moving average just like the Envelope. Bollinger Bands is a leading indicator. The upper and lower band of the indicator expands and contracts according to the volatility. In this strategy, we are using the default settings of both of these indicators to identify the signals.
The strategy is simple. When the prices hit the lower Bollinger band and lower bound of the Envelope indicator, it is a buy signal for us.
In the below NZD/USD chart, the market was in an uptrend. As the price reached the Bollinger bands and crossed the lower bound of the envelope, it generates a buy signal. In an active strong market, you can even use the support/resistance area of the higher timeframe to exit your trade. Generally, this strategy easily gives you 3 – 4 trades, because when the price hits the Bollinger band along with the envelope bound at the same time, the market often gives a reversal. This is a proven strategy and works on any timeframe.
The strategy is simple. When the prices hit the upper Bollinger band and upper bound of the Envelope indicator, it is a sell signal for us.
As you can see in the below GBP/JPY 15-Minute chart, the price hits the envelope upper bound and the upper Bollinger band, hence it is a reliable sell signal. When prices hit both of the upper bands and give us a reversal, the signal is said to be more accurate and robust. This is because the upper band acts as a solid wall to the price action. You can put the stop-loss just above the previous candle high, and ride the move down to the recent low.
The Envelope is a trend following indicator, but it also works well in the ranging market.
It is quite a popular indicator among the technical traders. The indicator helps you to ride the ongoing trend but it is not capable of identifying a brand new trend.
To trade successfully by using the envelope indicator, pair it with some other indicator, price action or candlestick patterns.
Let us know if this indicator has helped you in winning any of your trades. All the best.