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Moving Average Envelopes Trading Strategy

Author: ChaoZhang, Date: 2023-12-26 15:55:43
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Overview

The Moving Average Envelopes trading strategy is a trend following strategy. It sets up percentage envelopes above and below a moving average line as trading signals when price breaks out the envelopes. The strategy can be used for both trend following and identifying overbought/oversold market conditions.

Strategy Logic

The strategy is based on a 14-period simple moving average (SMA). The upper envelope is calculated as: SMA + SMA × input percentage. The lower envelope is calculated as: SMA - SMA × input percentage. This forms up and down trading bands parallel to the SMA.

When close price goes above the upper band, a long position is taken. When close price goes below the lower band, a short position is taken. Otherwise, maintain a flat position. The input parameter “reverse” allows reverse trading.

The strategy uses 3 indicators:

  1. xSMA - 14-period simple moving average, the midline.

  2. xHighBand - Upper percentage envelope.

  3. xLowBand - Lower percentage envelope.

Advantages

The advantages of this strategy include:

  1. Simple logic, easy to understand and implement.

  2. Can be used for both trend following and identifying overbought/oversold levels. Avoids missing trends in rangy markets.

  3. Trade frequency can be controlled by adjusting the percentage envelopes parameters. Lowers trading risk.

  4. Flexibility in choosing moving average periods for different timeframes and instruments.

  5. The reverse input parameter adds flexibility. Can trade with or against the trend.

Risks and Solutions

There are some risks to the strategy:

  1. Deep pullbacks beyond the envelope range can happen in strong trends, missing some profits. Can lower percentage parameters to control risk.

  2. Frequent false signals may occur in choppy/ranging markets. Can increase moving average period to filter signals.

  3. Too narrow envelopes may trigger excessive whipsaws. Can wisely widen envelope range.

  4. Sudden volatility from news events can cause losses. Using stop loss helps manage risk.

Optimization

The strategy can be optimized:

  1. Test moving averages of different periods and find optimal parameters with best signals.

  2. Optimize percentage envelopes for maximum profitability and controllable risk.

  3. Adding filters like MACD and KD to avoid bad signals in choppy/complex market conditions.

  4. Combine with trend strength indicators like ADX to improve entry timing.

  5. Test effectiveness across different instruments. Customize parameters per product.

  6. Incorporate stop loss strategy to limit downside risk per trade.

Conclusion

Overall this is a typical trend following strategy with easy backtesting parameters. It can also identify overbought/oversold levels. Further parameter optimization and combination with other indicators can significantly improve its practical effectiveness for trading. This is a valuable strategy worthy of further research and application.

/*backtest
start: 2023-11-25 00:00:00
end: 2023-12-25 00:00:00
period: 1h
basePeriod: 15m
exchanges: [{"eid":"Futures_Binance","currency":"BTC_USDT"}]
*/

//@version=2
////////////////////////////////////////////////////////////
//  Copyright by HPotter v1.0 04/03/2018
// Moving Average Envelopes are percentage-based envelopes set above and 
// below a moving average. The moving average, which forms the base for 
// this indicator, can be a simple or exponential moving average. Each 
// envelope is then set the same percentage above or below the moving average. 
// This creates parallel bands that follow price action. With a moving average 
// as the base, Moving Average Envelopes can be used as a trend following indicator. 
// However, this indicator is not limited to just trend following. The envelopes 
// can also be used to identify overbought and oversold levels when the trend is 
// relatively flat. 
//
// You can change long to short in the Input Settings
// WARNING:
//  - For purpose educate only
//  - This script to change bars colors.
////////////////////////////////////////////////////////////
strategy(title="Moving Average Envelopes", overlay = true)
Length = input(14, minval=1)
PercentShift = input(1, minval = 0.01, step = 0.01)
reverse = input(false, title="Trade reverse")
xSMA = sma(close, Length)
xHighBand = xSMA + (xSMA * PercentShift / 100)
xLowBand = xSMA - (xSMA * PercentShift / 100)
pos = iff(close > xHighBand, 1,
       iff(close <xLowBand, -1, nz(pos[1], 0))) 
possig = iff(reverse and pos == 1, -1,
          iff(reverse and pos == -1, 1, pos))	   
if (possig == 1) 
    strategy.entry("Long", strategy.long)
if (possig == -1)
    strategy.entry("Short", strategy.short)	   	    
barcolor(possig == -1 ? red: possig == 1 ? green : blue ) 
plot(xSMA, color=blue, title="SMA")
plot(xHighBand, color=red, title="High Band")
plot(xLowBand, color=red, title="Low Band")
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