Monday, October 31, 2011

Moving Average Envelopes

A simple moving average line can be enhanced by surrounding the line pattern with parallel envelopes. These envelopes deviate from the the moving average line by a user-specified percentage in order to determine when prices have strayed from the moving average line by that percentage. For example, charting 3% envelopes would display an upper parallel line that is 3% above the MA line, and a lower parallel line that is 3% below the MA line.


The chart for Cisco (CSCO) shows 3% envelopes placed around a 20-day moving average of the security. Notice how during the downtrend the upper envelope was never touched, while the lower envelope was touched repeatedly. 

Moves outside of the 3% envelopes are significant for short term traders who are more concerned with smaller price fluctuations. A short term analysis would see prices outside of the 3% envelopes as overextended. On the other hand, a long range analysis might focus on prices outside of 5% or 10% envelopes that surround a 10-week or 40-week average.

Moving Average Envelopes and SharpCharts

With SharpCharts, moving average envelopes can be plotted as a price overlay. The first parameter specifies the number of periods for the moving average (default 20), and the second parameter sets the percentage difference between the envelopes and the moving average line (default 2.5).