diff --git a/extension.js b/extension.js
index 212a597..64c03c0 100644
--- a/extension.js
+++ b/extension.js
@@ -1,8 +1,10 @@
+const vscode = require('vscode')
 const autocloaking = require('./lib/autocloaking')
 const autocompletion = require('./lib/autocompletion')
 const commands = require('./lib/commands')
 const peeking = require('./lib/peeking')
 const fileAssociations = require('./lib/fileAssociations')
+const helpers = require('./lib/helpers')
 
 async function activate (context) {
   console.log('Dotenv is active')
@@ -21,6 +23,27 @@ async function activate (context) {
 
   console.log('Load autocloaking')
   await autocloaking.run(context)
+
+  // Watch for .env file changes to invalidate cache
+  console.log('Setup .env file watcher')
+  const envFileWatcher = vscode.workspace.createFileSystemWatcher('**/.env*')
+
+  envFileWatcher.onDidCreate(() => {
+    console.log('.env file created, clearing cache')
+    helpers.clearEnvFileCache()
+  })
+
+  envFileWatcher.onDidDelete(() => {
+    console.log('.env file deleted, clearing cache')
+    helpers.clearEnvFileCache()
+  })
+
+  envFileWatcher.onDidChange(() => {
+    console.log('.env file changed, clearing cache')
+    helpers.clearEnvFileCache()
+  })
+
+  context.subscriptions.push(envFileWatcher)
 }
 
 function deactivate () {
diff --git a/lib/helpers.js b/lib/helpers.js
index 5de7328..c3851d8 100644
--- a/lib/helpers.js
+++ b/lib/helpers.js
@@ -1,7 +1,109 @@
 const vscode = require('vscode')
 const dotenv = require('dotenv')
+const fs = require('fs')
+const path = require('path')
 const settings = require('./settings')
 
+// Memoization cache: maps directory path to found .env file path (or null if none found)
+const envFileCache = new Map()
+
+// Priority order for .env files (higher priority first)
+const ENV_FILE_PRIORITY = ['.env.local', '.env']
+
+/**
+ * Get all .env* files in a directory, sorted by priority
+ * @param {string} dirPath - Directory to search
+ * @returns {string[]} Array of .env file paths, sorted by priority
+ */
+function getEnvFilesInDirectory (dirPath) {
+  try {
+    const files = fs.readdirSync(dirPath)
+    const envFiles = files.filter(file => file.startsWith('.env'))
+
+    // Sort by priority: .env.local first, then .env, then others alphabetically
+    return envFiles.sort((a, b) => {
+      const priorityA = ENV_FILE_PRIORITY.indexOf(a)
+      const priorityB = ENV_FILE_PRIORITY.indexOf(b)
+
+      // If both are in priority list, sort by priority
+      if (priorityA !== -1 && priorityB !== -1) {
+        return priorityA - priorityB
+      }
+      // If only a is in priority list, a comes first
+      if (priorityA !== -1) return -1
+      // If only b is in priority list, b comes first
+      if (priorityB !== -1) return 1
+      // Otherwise sort alphabetically
+      return a.localeCompare(b)
+    }).map(file => path.join(dirPath, file))
+  } catch (err) {
+    return []
+  }
+}
+
+/**
+ * Find the nearest .env* file starting from startPath and walking up the directory tree
+ * @param {string} startPath - Starting directory path
+ * @returns {string|null} Path to the nearest .env file, or null if not found
+ */
+function findNearestEnvFile (startPath) {
+  // Check cache first
+  if (envFileCache.has(startPath)) {
+    return envFileCache.get(startPath)
+  }
+
+  // Get workspace root as boundary (don't go above it)
+  const workspaceRoot = vscode.workspace.workspaceFolders
+    ? vscode.workspace.workspaceFolders[0].uri.fsPath
+    : null
+
+  let currentDir = startPath
+  const visitedDirs = []
+
+  while (currentDir) {
+    visitedDirs.push(currentDir)
+
+    const envFiles = getEnvFilesInDirectory(currentDir)
+    if (envFiles.length > 0) {
+      const envFilePath = envFiles[0] // Use highest priority file
+
+      // Cache result for all visited directories
+      for (const dir of visitedDirs) {
+        envFileCache.set(dir, envFilePath)
+      }
+
+      return envFilePath
+    }
+
+    // Stop if we've reached workspace root or filesystem root
+    if (workspaceRoot && currentDir === workspaceRoot) {
+      break
+    }
+
+    const parentDir = path.dirname(currentDir)
+    if (parentDir === currentDir) {
+      // Reached filesystem root
+      break
+    }
+
+    currentDir = parentDir
+  }
+
+  // No .env file found - cache null for all visited directories
+  for (const dir of visitedDirs) {
+    envFileCache.set(dir, null)
+  }
+
+  return null
+}
+
+/**
+ * Clear the env file cache. Called when .env files change.
+ */
+function clearEnvFileCache () {
+  envFileCache.clear()
+}
+
 function envEntries () {
   const parsed = envParsed()
 
@@ -15,12 +117,33 @@ function envEntries () {
 }
 
 function envParsed () {
-  const workspacePath = vscode.workspace.workspaceFolders ? vscode.workspace.workspaceFolders[0].uri.fsPath.replace(/\\/g, '/') : undefined // /path/to/project/folder
+  let envFilePath = null
+
+  // Try monorepo support first if enabled
+  if (settings.monorepoSupportEnabled()) {
+    const activeEditor = vscode.window.activeTextEditor
+    if (activeEditor) {
+      const documentPath = activeEditor.document.uri.fsPath
+      const documentDir = path.dirname(documentPath)
+      envFilePath = findNearestEnvFile(documentDir)
+    }
+  }
+
+  // Fall back to workspace root if no file found or monorepo support disabled
+  if (!envFilePath) {
+    const workspacePath = vscode.workspace.workspaceFolders
+      ? vscode.workspace.workspaceFolders[0].uri.fsPath.replace(/\\/g, '/')
+      : undefined
+
+    if (workspacePath) {
+      envFilePath = path.join(workspacePath, '.env')
+    }
+  }
 
   let parsed = {}
 
-  if (workspacePath) {
-    parsed = dotenv.config({ path: `${workspacePath}/.env` }).parsed
+  if (envFilePath) {
+    parsed = dotenv.config({ path: envFilePath }).parsed
   } else {
     parsed = dotenv.config().parsed
   }
@@ -124,3 +247,6 @@ module.exports.envEntries = envEntries
 module.exports.envParsed = envParsed
 module.exports.hover = hover
 module.exports.autocomplete = autocomplete
+module.exports.findNearestEnvFile = findNearestEnvFile
+module.exports.getEnvFilesInDirectory = getEnvFilesInDirectory
+module.exports.clearEnvFileCache = clearEnvFileCache
diff --git a/lib/settings.js b/lib/settings.js
index b012a45..8c202c8 100644
--- a/lib/settings.js
+++ b/lib/settings.js
@@ -6,6 +6,7 @@ const enableAutocloakingKey = 'dotenv.enableAutocloaking'
 const cloakColorKey = 'dotenv.cloakColor'
 const cloakIconKey = 'dotenv.cloakIcon'
 const enableSecretpeekingKey = 'dotenv.enableSecretpeeking'
+const enableMonorepoSupportKey = 'dotenv.enableMonorepoSupport'
 
 // other settings from vscode or other extensions
 const editorTokenColorCustomizationsKey = 'editor.tokenColorCustomizations'
@@ -72,6 +73,12 @@ function cloakIcon () {
   return userConfig().get(cloakIconKey)
 }
 
+function monorepoSupportEnabled () {
+  const value = userConfig().get(enableMonorepoSupportKey)
+  // Default to true if not explicitly set
+  return value === undefined ? true : !!value
+}
+
 // other settings
 function _editorTokenColorCustomizations () {
   return userConfig().get(editorTokenColorCustomizationsKey)
@@ -132,6 +139,7 @@ module.exports.autocloakingEnabled = autocloakingEnabled
 module.exports.secretpeekingEnabled = secretpeekingEnabled
 module.exports.cloakColor = cloakColor
 module.exports.cloakIcon = cloakIcon
+module.exports.monorepoSupportEnabled = monorepoSupportEnabled
 
 // other
 module.exports.missingText = missingText
diff --git a/package.json b/package.json
index a86e85b..4517300 100644
--- a/package.json
+++ b/package.json
@@ -60,6 +60,12 @@
           "type": "string",
           "default": "█",
           "description": "Change the icon of the cloak for your .env files"
+        },
+        "dotenv.enableMonorepoSupport": {
+          "scope": "resource",
+          "type": "boolean",
+          "default": true,
+          "description": "When enabled, searches for .env files starting from the active file's directory and walking up the tree. When disabled, uses workspace root."
         }
       }
     },
diff --git a/test/suite/examples/monorepo/.env b/test/suite/examples/monorepo/.env
new file mode 100644
index 0000000..a4a784a
--- /dev/null
+++ b/test/suite/examples/monorepo/.env
@@ -0,0 +1,2 @@
+ROOT_VAR=root
+SHARED_VAR=from_root
diff --git a/test/suite/examples/monorepo/packages/app-a/.env b/test/suite/examples/monorepo/packages/app-a/.env
new file mode 100644
index 0000000..114d10d
--- /dev/null
+++ b/test/suite/examples/monorepo/packages/app-a/.env
@@ -0,0 +1,2 @@
+APP_A_VAR=appA
+SHARED_VAR=from_app_a
diff --git a/test/suite/examples/monorepo/packages/app-a/.env.local b/test/suite/examples/monorepo/packages/app-a/.env.local
new file mode 100644
index 0000000..30a9c3c
--- /dev/null
+++ b/test/suite/examples/monorepo/packages/app-a/.env.local
@@ -0,0 +1 @@
+LOCAL_VAR=local_value
diff --git a/test/suite/examples/monorepo/packages/app-a/src/index.js b/test/suite/examples/monorepo/packages/app-a/src/index.js
new file mode 100644
index 0000000..9da5ccd
--- /dev/null
+++ b/test/suite/examples/monorepo/packages/app-a/src/index.js
@@ -0,0 +1,2 @@
+// Test file for monorepo support
+console.log(process.env.APP_A_VAR)
diff --git a/test/suite/examples/monorepo/packages/app-b/src/index.js b/test/suite/examples/monorepo/packages/app-b/src/index.js
new file mode 100644
index 0000000..3f4f52c
--- /dev/null
+++ b/test/suite/examples/monorepo/packages/app-b/src/index.js
@@ -0,0 +1,2 @@
+// Test file for monorepo support - no local .env, should use root
+console.log(process.env.ROOT_VAR)
diff --git a/test/suite/lib/helpers.test.js b/test/suite/lib/helpers.test.js
index 9e48e9d..7490684 100644
--- a/test/suite/lib/helpers.test.js
+++ b/test/suite/lib/helpers.test.js
@@ -1,10 +1,14 @@
-const mocha = require('mocha')
-const describe = mocha.describe
-const it = mocha.it
 const assert = require('assert')
+const path = require('path')
 
 const helpers = require('../../../lib/helpers')
 
+// Path to test fixtures
+const monorepoRoot = path.join(__dirname, '..', 'examples', 'monorepo')
+const appADir = path.join(monorepoRoot, 'packages', 'app-a')
+const appASrcDir = path.join(appADir, 'src')
+const appBSrcDir = path.join(monorepoRoot, 'packages', 'app-b', 'src')
+
 describe('helpers', function () {
   describe('#envParsed', function () {
     it('returns envParsed', function () {
@@ -21,4 +25,93 @@ describe('helpers', function () {
       assert.deepEqual(result[0], ['HELLO', 'World'])
     })
   })
+
+  describe('#getEnvFilesInDirectory', function () {
+    it('returns empty array for directory with no .env files', function () {
+      const result = helpers.getEnvFilesInDirectory(appASrcDir)
+      assert.deepEqual(result, [])
+    })
+
+    it('returns all .env* files in directory', function () {
+      const result = helpers.getEnvFilesInDirectory(appADir)
+      assert.strictEqual(result.length, 2)
+      // Files should be present
+      assert.ok(result.some(f => f.endsWith('.env')))
+      assert.ok(result.some(f => f.endsWith('.env.local')))
+    })
+
+    it('prioritizes .env.local over .env', function () {
+      const result = helpers.getEnvFilesInDirectory(appADir)
+      const envLocalIndex = result.findIndex(f => f.endsWith('.env.local'))
+      const envIndex = result.findIndex(f => f.endsWith('.env') && !f.endsWith('.env.local'))
+      assert.ok(envLocalIndex < envIndex, '.env.local should come before .env')
+    })
+
+    it('returns .env files in monorepo root', function () {
+      const result = helpers.getEnvFilesInDirectory(monorepoRoot)
+      assert.strictEqual(result.length, 1)
+      assert.ok(result[0].endsWith('.env'))
+    })
+  })
+
+  describe('#findNearestEnvFile', function () {
+    beforeEach(function () {
+      // Clear cache before each test
+      helpers.clearEnvFileCache()
+    })
+
+    it('returns .env in same directory when present', function () {
+      const result = helpers.findNearestEnvFile(appADir)
+      // Should find .env.local (higher priority) in app-a directory
+      assert.ok(result.endsWith('.env.local'))
+      assert.ok(result.includes('app-a'))
+    })
+
+    it('walks up to find .env in parent directory', function () {
+      // app-b/src has no .env, should walk up to monorepo root
+      const result = helpers.findNearestEnvFile(appBSrcDir)
+      assert.ok(result !== null)
+      assert.ok(result.endsWith('.env'))
+      assert.ok(result.includes('monorepo'))
+      assert.ok(!result.includes('app-b'))
+    })
+
+    it('returns null when no .env found', function () {
+      // Use a directory that doesn't exist or has no .env in tree
+      const result = helpers.findNearestEnvFile('/tmp')
+      assert.strictEqual(result, null)
+    })
+
+    it('caches results for faster subsequent lookups', function () {
+      // First call
+      helpers.findNearestEnvFile(appASrcDir)
+
+      // Second call should use cache (we can't easily verify this,
+      // but we can verify it returns the same result)
+      const result = helpers.findNearestEnvFile(appASrcDir)
+      assert.ok(result !== null)
+      assert.ok(result.includes('app-a'))
+    })
+
+    it('cache can be cleared', function () {
+      // Populate cache
+      helpers.findNearestEnvFile(appASrcDir)
+
+      // Clear cache
+      helpers.clearEnvFileCache()
+
+      // Should still work after clearing (will repopulate cache)
+      const result = helpers.findNearestEnvFile(appASrcDir)
+      assert.ok(result !== null)
+    })
+  })
+
+  describe('#clearEnvFileCache', function () {
+    it('clears the cache without throwing', function () {
+      // Should not throw
+      assert.doesNotThrow(() => {
+        helpers.clearEnvFileCache()
+      })
+    })
+  })
 })