An envelope is comprised of two moving averages.
One moving average is shifted upward and the second moving average is shifted downward.
Envelopes define the upper and lower boundaries of a
security's normal trading range. A sell signal is generated when the security reaches the
upper band whereas a buy signal is generated at the lower band. The optimum percentage
shift depends on the volatility of the security--the more volatile, the larger the
The logic behind envelopes is that overzealous buyers and
sellers push the price to the extremes (i.e., the upper and lower bands), at which point
the prices often stabilize by moving to more realistic levels. This is similar to the
interpretation of Bollinger Bands.
The lower band is the moving average shifted
down by the same number of standard deviations (i.e., "D").
The following chart displays a stock with a
6% envelope of a 25-day exponential moving average.: