MOVING AVERAGE ENVELOPE

Charles LeBeau and David Lucas review many indicators and show them as entry trigger examples in their book, Computer Analysis of the Futures Market. In the Envelopes, Bands and Channels section, they show an example of using a Moving Average Envelope. Many examples of envelope trading use them as reversal systems that are always in the market. We know that markets don't always trend so our preference is to change the system. Below shows the system using a stop, having a neutral zone, and not being in the market all the time but only when the entry trigger occurs.

ENTRY

Use a moving average envelope by adding a percentage above and below your moving average line. Examples include 2.5% mentioned on the stockcharts.com page above to 5% mentioned in Charles Le Beau and David Lucas' book. The entry trigger is when the price breaks out of the envelopes by crossing or closing outside the envelopes. With the price going outside of the envelopes it can indicate the beginning of a trend. A long position occurs when the price goes above the upper envelope line. A short position occurs when the price goes below the lower envelope line. As the trend continues in your favor, you can add additional positions to increase profits and keep your risk the same as long as you move your stop closer with any pyramid positions.

POSITION SIZING

Since Technical Traders Guide to Computer Analysis of the Futures Market doesn't mention a good position sizing formula, we'll use Percent Volatility Position Sizing with this system. Calculate the value of the distance of the entry price to the stop price. Calculate the amount of risk per trade or percentage of your equity you want to put on the line if the trade goes against you (2% or less in most cases). Divide the amount to be risked by the value of the price distance to the stop, round down to a whole amount available for a position and you'll have your position size. With this position sizing, you limit your risk if the trade goes against you so you can cut your losses short and let your profits run. For a futures example we'll use a long gold (GC) position at 1634.20 with a 10 day ATR of 73.5 that has a tick size of 0.1 and each tick of movement is $0.10. If we have a $100,000 account and we are willing to risk 2%, we only want $2,000 on the line. We take our $2,000 and divide it by our 1470 ticks of movement (10 day ATR * 2) until our stop since it is worth $0.10 for each tick. $2,000 รท $147 ends up being 13.605 contracts that we will round down to 13 contracts. That is our position size to limit our risk to less than 2% of our trading equity while still allowing room for the price to move in its range.

STOP

Set the stop by using a multiple of ATR such as 2 * 10 day ATR like the example above. If you don't want to use ATR but still want a stop that accounts for volatility you can instead use the opposite bollinger band from the side of the entry price or a multiple of BandWidth.

EXIT

Parabolic SAR follows the price but may exit before the trend is finished. You can try an exit that occurs when the price touches the moving average or the opposite moving average envelope line.

VARIATIONS

Since the envelope is based solely on a moving average, it doesn't account for volatility like Bollinger Bands or the ATR Envelope system. If your exit is a static length like the opposite envelope you may be whipsawed. In this case have additional entry criteria to reenter the position if the price resumes along the envelope line. Another suggestion throughout most of the indicators that Charles Le Beau and David Lucas review is to add filtering with ADX.

MORE DETAILS

For more details on envelope trading and valuable system design with testing, read Computer Analysis of the Futures Market.

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