Let’s review how to identify overbought and oversold levels with moving average envelopes.
There will also be times when the price initially moves above or below an envelope but turns back around.
This usually happens when the moving average slope is FLAT.
When this happens, moving average envelopes can be used to identify overbought and oversold levels.
If the price moves above the upper envelope, this can be considered overbought.
When the price moves below the lower envelope, this can be considered oversold.
Identifying overbought and oversold levels isn’t easy though.
Remember, a currency pair can become overbought and remain overbought when the bullish trend is strong.
The same goes for being oversold. In a strong bearish trend, something can be technically oversold but remain oversold for quite some time.
This is why it’s best to pay attention to the slope of the moving average and make sure it’s flat.
You should confirm overbought and oversold levels with support and resistance levels.
If the price touches or falls beneath the LOWER envelope, then rises back above, buy.
If the price touches or rises above the UPPER envelope, then falls back below, sell.
In the chart below, notice how the 30 SMA (orange line) and the upper and lower envelopes (blue lines) are flat…almost horizontal even.
EUR/JPY is directionless here. There is no strong bullish trend, nor is there a strong bearish trend.
Observe how the upper envelope acts as a strong resistance level.
Whenever the price traded near the upper envelope, the price would fall back down.
The same with the lower envelope. Observe how it acts as a strong support level.
Whenever the price traded near the lower envelope, the price would bounce back up.
Moving average envelopes (MAE) are used as a tool to confirm trend direction, but can also be used in sideways markets to identify overbought and oversold levels.
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