The Envelopes indicator is based upon moving averages and is commonly referred to as Moving Average Envelopes. Similar to its name, the envelopes indicator comprises of the main moving average, which is defaulted to 14 periods with the upper and lower bands of the envelopes set to 1% deviation. The values of which of course can be changed. While the standard MT4 envelopes indicator does not plot the moving average or the middle line of the envelopes, traders can further add a 14 period EMA to plot the middle line.
The upper and lower bounds of the envelopes represent the amount of deviation from the main moving average line. The envelopes indicator therefore works on the principles of reversion to the mean, where prices that are trading at extremes often deviate towards their average price. It is based on this concept that buy and sell signals are often taken when price trades at or near the lower and upper bands. However, in periods of extreme or strong trends, price can continue to trade near the upper or lower ends of the bands for prolonged periods of time.
The deviation factor can and must be changed depending on the security it is being applied to as volatility changes from one instrument to the other, besides the look back period itself which is generally set to 20 periods when applying this indicator to the daily chart intervals.
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