Moving Average Envelopes consist of moving averages calculated from the underling price, shifted up and down by a fixed percentage. Moving Average Envelopes (or trading bands) can be imposed over an actual price
They are used to indicate overbought and oversold levels and can be traded on their own or in conjunction with a momentum indicator. It is used to identify trading ranges by the assumption that price should not deviate from the average of the underlying price element (high or low) by the percentage utilized.
When prices rise above the upper band or fall below the lower band, a change in direction may occur when the price penetrates the band after a small reversal from the opposite direction.
Some traders use the moving average envelope to determine when a price is “cheap” or “expensive” (e.g. buy when price is near the bottom of the envelope, don’t buy when price is near the top of the envelope), but it should be noted that in a strongly trending market, price is likely to stay in the upper part of the envelope for lengthy periods, and a trader waiting for “cheapness” on this test in such a market, may miss the major part of the move.