Envelopes, or Trading Bands, are used to show the upper and lower limits of a security's normal trading range.
This indicator is composed of two bands, which are formed by taking a security's Moving Average and shifting it up and down by a certain percentage. For example, you might shift the Moving Average up 5% to create the upper band and down 5% to create the lower band. In general, 90% of the price activity should be contained within the two envelopes.
Similar to how Bollinger Bands® are interpreted, sell signals are believed to be generated when the security nears the upper band and buy signals are believed to be generated when the security's value approaches the lower band.
Prices tend to move back and forth between the higher and lower outer bands in a range-bound market, when prices are moving sideways. As a result, some analysts recommend purchasing the security when the price reaches the low band and selling when the security reaches the high band, as prices will typically reverse upon reaching either of the outer bands.
In a trending market, prices will tend to stay above the Moving Average in an uptrend and below the Moving Average in a downtrend. However, prices will still tend to fluctuate between the Moving Average and either the upper or lower band - depending on whether the price is on an up- or a downtrend - so proponents assert you can use the same general technique for deciding when to buy and sell. For example, in an uptrend, a buy signal is generated when the price nears the Moving Average and a sell signal is created when it nears the upper band.
Envelopes can also be used to determine whether a security is overbought and oversold. As prices move closer to the upper band, it may be a sign that a security is overbought, and prices moving toward the lower band could indicate that the security is oversold.
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.