Moving Average Envelopes

Stock Trading Bands

Moving average envelopes are a pair of lines also known as trading bands, and may sometimes also be referred to as price envelopes, moving average bands or percentage envelopes. As the combination of different names suggest, moving average envelopes aim to identify a band within which a stock is trading. They are based upon a chosen moving average, and run in exactly the same pattern but one of the envelope lines runs slightly above the moving average and the other envelope line runs slightly below the moving average, thus creating the "trading band" in between the two envelope lines.

Calculation and Formation of Moving Average Envelopes

Initially, a moving average needs to be calculated. This can either be a simple moving average or an exponential moving average. A typical number of days data to use when calculating the moving average for the purpose of creating the envelope is 35 or 45 days. However, as with most technical analysis indicators, the number of days you use in your period of data can be higher or lower - the higher number of days data you use, the smoother the curves of your envelope will be. Conversely, if you use a lower number of days in your calculation of the moving average, a more volatile-curvy looking envelope wll be created.

Once the moving average has been calculated, the top envelope point for a particular day is calculated by adding a certain percentage to the moving average figure for that day. The percentage figure used may depend on the volatility of the stock, but often is a value of around 5% is used, with figures of 2% to 6% also being reasonably common.

Thus, using 5% as an example the calculation, the calculation for the top band is:
Top band = Moving Average + (Moving Average x 5 ÷ 100)

The bottom band is always calculated using the same percentage as the bottom band, but the percentage is deducted:
Bottom band = Moving Average - (Moving Average x 5 ÷ 100)

Interpretation of Moving Average Envelopes

The moving average envelopes can be helpful in identifying overbought or oversold conditions, where stock or share prices hit the top or bottom of their trading range. Quite often a stock which is oversold or overbought may stay that way for a while, however, therefore it is probably best to make decisions on whether to buy or sell using moving average envelopes in conjunction with other technical analysis indicators rather than on their own. I have seen one trader report good results using a stochastic indicator with the same number of days as the moving average, in conjunction with studying the envelopes.