Linear Regression Channel

Linear Regression Channel

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Great for ranging as well as trending conditions

The Linear Regression Channel (LRC)

The LRC is designed as a trend-identifying reversion to the mean indicator

The LRC is a dynamic indicator, it is not static. As price action changes the linear regression lines will automatically adjust and the channel will become up trending, down trending, or sideways depending on current market conditions. It can be applied to any market on any time frame, and is a valuable tool for swing trading as well as intraday.

The LRC – A Truly Universal Indicator

The linear regression channel uses the financial instruments price and time period to determine its system parameters. It works in real-time on your chart, continuously adapting to market movements. Applying it to price movement can accurately predict future price movement and trend reversals.

The LRC is the only indicator that can truly detect when prices are overbought or oversold

Why do I use the Linear Regression Channel?

Because ‘smart money’ uses it! Smart money and large institutions utilise linear regression channels because even they recognise that the LRC indicator tends to be predictive in nature (in fact it’s one of the only indicators they WILL use). The Smart Money also know that the LRC is one of the RARE indicators that work in both ranging AND trending conditions. They are right too! (the LRC is the ONLY indicator I will use when price is ranging, and it works extremely well)

 

  • Trend-identifying reversion to the mean indicator
  • Works in both trending and ranging conditions
  • Predictive in nature, smart money use this indicator
  • Plots a channel & rotates with price
  • The channel width is determined by the level of price volatility
  • The length of the channel is adjustable
  • Displays signal arrows for both deviation 1 and 2 outer lines
  • Can be used on any instrument and timeframe
  • User manual – 12 page PDF of comprehensive step by step Instructions with pics

Linear Regression Channel Indicator package

$39

Not familiar with “Smart Money” concepts? Want to learn? Each of my products come with a FREE 12 hour Smart Money Video course (in full 1080 HD) by one of my mentors, a VERY valuable education that gives you the trading edge over smart money.

$39 – Purchase the Linear Regression Channel indicator package via Paypal. 

Instant download after payment

Most retail traders focus on trend indicators and oscillators…

If you ask retail traders what their favourite indicator is, the answers always look the same. You’ll hear all about the RSI (Relative Strength Index), Stochastics and the MACD (Moving Average Convergence Divergence). They’re the most popular ones.

But technical indicators today go in various other directions and can be much more complicated than a simple RSI calculation.

The linear regression channel is one of the lesser known technical indicators that plot its values based on mathematical formulas (at its heart, linear regression is a method of estimating the undefined relationship between price and time).

 

The Linear Regression of Time and Price

 

While there are many other technical indicators such as moving averages or oscillators, the linear regression channel actually falls into an advanced mode of calculation between price and time. Linear regression is a statistical tool used to predict the future from past data. It is used to determine when prices are overextended.

Linear regression channel trading strategies offer one of the best risk-reward ratios. No one can say a stop loss won’t be hit, but most of the times it won’t be, and moreover, when it doesn’t the resulting trade offers a larger than average reward.

Use the LRC and abide by the rules defined within this article on any financial instrument and timeframe you like, and I guarantee you will be surprised by its universal nature!

 

The standard MT4 LRC  vs  my Custom Coded LRC

 

Yes there is a standard LRC in MT4, well sort of.… its ‘kinda’ like a linear regression channel in the way that McDonalds is ‘kinda’ like a restaurant

The standard LRC can be found in Metatrader 4… (Go to the top ‘Insert’ tab / Channels / Linear Regression)

Standard MT4 LRC

 

• Static on chart – manual adjust
• Single outside lines
• Non-adjustable Deviation settings
• No signals at all

But my custom coded LRC offers many more features:

Master Trader Secrets custom LRC

 

• Dynamic (Auto updating)
• Double outside lines
• Adjustable channel length
• Adjustable Deviation settings
• Deviation 1 and 2 signal arrows

I have coded my LRC to have 2 separate Deviation lines (both top and bottom of the middle linear regression line) and both are adjustable.

This basically means:

  • The wider you set the channels the higher your tolerance threshold (less trading signals, but more reliable signals) or…
  • The narrower you set the channels, the lower your tolerance threshold (more trading signals, but less reliable signals).

The standard MT4 LRC indicator has only one deviation line that is above and below the middle linear regression line, and its not adjustable at all. Yup, basically its useless and it sucks.

My Linear Regression Channel Indicator is the best custom coded LRC for the Metatrader 4 platform!

 

LRC Construction

The linear regression channel is constructed from the inside out, it begins with a centre line (the equilibrium or ‘linear regression line’) and from that it plots the outer lines. Four additional lines are then drawn, both top and bottom (both outer channels having the same distance from the equilibrium line, with their corresponding distances being based on past price volatility).

The outer lines are created at 1 and 2 standard deviations outside of the median price. The  ‘inner’ channel lines contain 68% of all prices between them (if 1 standard deviation is used) or 95% of all prices (if 2 standard deviations are used).

  • If you set the inner deviation line at 1, you should see price stay within this boundary 68% of the time
  • If you set the outer deviation line at 2, you should see price stay within this boundary 95% of the time (this means that price only breaches this line 5% of the time)….

Effectively this means:

  • When price enters INSIDE the top or bottom deviation channel, price will reverse 68% of the time
  • When price goes OUTSIDE the top or bottom deviation channel, price will reverse 95% of the time!

Imagine if your trading strategy was to trade only when price goes OUTSIDE the top or bottom deviation channel. Price will then reverse 95% of the time….. Hmm, do you recognise any opportunities here? Lol

Now do you see why ‘smart money’ (and I) use the Linear Regression Channel?

 

The LRC consists of three parts:

 

  1. The Linear Regression Line

  2. The Upper Deviation Channel

  3. The Lower Deviation Channel

 

1 – The Linear Regression Line

The Linear Regression Line acts as the midpoint of the trend. Think of it as the equilibrium price, or the baseline, where any move above or below the linear regression line indicates overzealous buyers or sellers.

 

2 – The Upper deviation Channel

The Upper deviation Channel is 2 lines that run parallel to the Linear Regression Line. It marks the top of the trend.

  • The inner line represents one standard deviation above the Linear Regression Line and contains 68% of price data
  • The outer line is 2 standard deviations above the Linear Regression Line and contains 95% of price data

The use of standard deviation gives traders an idea as to when prices are becoming overbought or oversold, relative to the long term trend.

When price ventures into or outside the boundaries of the upper deviation channel, these extremes are routinely corrected and you can expect price to move back towards the Linear Regression Line (which means that these price breaches outside the boundaries are considered as selling opportunities)

 

3 – The Lower deviation Channel

The Lower deviation Channel is 2 lines that run parallel to the Linear Regression Line. It marks the bottom of the trend.

  • The inner line represents one standard deviation below the Linear Regression Line and contains 68% of price data
  • The outer line is 2 standard deviations below the Linear Regression Line and contains 95% of price data!

The use of standard deviation gives traders an idea as to when prices are becoming overbought or oversold, relative to the long term trend.

When price ventures into or outside the boundaries of the lower deviation channel, these extremes are routinely corrected and you can expect price to move back towards the Linear Regression Line (which means that these price breaches outside the boundaries are considered as buying opportunities)

The Bell curve

So how do we work out where these price breaches occur?

One way is to utilise the statistical concept of a normal distribution, and the accompanying measure of standard deviation. To better understand this standard deviation Forex strategy, let’s quickly have a run through of what I mean by these terms.

A normal distribution is a probability distribution that follows a bell-shaped curve. The bell curve represents the form of the various data point occurrences. The bulk of the points normally take place toward the middle of the bell curve, but over time, the points stray, or deviate from the population…

The highest probability density is centred around the mean (the Linear Regression Line) and is represented by the thick black line in the diagram above. An important point to note is that all normal distributions are symmetrical. This places both the mean and the median at the exact centre of the bell curve.

Standard deviation is another statistical measure, and quantifies how scattered the values are within a data set. The larger the standard deviation, the wider the bell curve. The mathematics that govern this curve are relatively complex. But here’s the good news: the concept that it represents is actually fairly simple.

The further we get away from the middle of the bell, the smaller the chances are of those values of X occurring. This means that the majority of values for X occur one standard deviation either side of the mean. In fact, in a normal distribution, we would expect around 68% of the data values to occur in this range.

Two standard deviations either side of the mean cover roughly 95% of all data values. At the tails of the curve we get the outliers, and these are rarer occurrences.

Why does this matter? Well if we see a data value that is an outlier, it is a fair assumption that future values will regress back towards the mean…

 

Trading with the Linear Regression Channel

 

The Linear Regression Channel gives potential buy and sell signals based on price volatility. Trading the Linear Regression Channel involves keeping an eye on the price whenever it interacts with one of the three lines.

Each time that the price interacts with the Upper or Lower Channel:

  • You should expect to see a potential turning point on the price chart
  • The goal is to fade these extremes and look for price to return to the linear regression line, and potentially to the other side of the channel
  • When price closes outside of the Linear Regression Channel for long periods of time, this is often interpreted as an early signal that the past price trend may be breaking and a significant reversal might be near

Buy Signal

  • If you expect a continuation of the trend and price falls into or exceeds the lower deviation channel, this is considered a buy signal (you should wait for confirmation by waiting for the price to move higher and close back inside the linear regression channel)

Sell Signal

  • If you expect a continuation of the trend and price rises into or exceeds the upper deviation channel, this is considered a sell signal (you should wait for confirmation by waiting for the price to move lower and close back inside the linear regression channel)

 

Stop Loss on a Linear Regression Trade

 

You should always use a stop loss when trading a Linear Regression based strategy.

  • If you are trading a bullish linear regression setup, the stop loss should be placed just below the swing low created by the price bounce from the lower deviation channel
  • Conversely, if you are trading a bearish linear regression setup, your stop loss should be placed just above the swing high created by the price bounce from the upper deviation channel

 

Linear Regression Trading Strategy (Bullish):

 

  • Enter a trade when the price bounces from the lower deviation channel (an accompanying signal arrow being a bonus) and heads back towards the mean
  • Place your stop loss below the bottom created prior to the bounce
  • Hold the trade until one of the following conditions is met:
    • Price reaches the linear regression line (mean) but can go no further and starts to reverse
    • Price reaches the top deviation channel
  • Price completely breaks the top deviation channel and a trend opposing signal arrows appears against you

(Simply reverse the procedure for a bearish trade strategy)

 

A bullish trade example using four points of reference

  • 1 is the entry point. This only becomes an entry point when the price has traded into the lower deviation channel and has started to move back inside the one standard deviation line (you don’t simply enter without confirming that price has started to turn back, because it may go further). Instead, we want the outlying event to have taken place and the price to indicate it is reverting back to the mean. A move back within the first standard deviation confirms the regression.
  • 2 provides a stop-loss point in case price continues to move against you
  • 3 and 4 will be the two price targets you can set for profitable trade exits:
    • Our first expectation with the trade was for price to revert to the mean, so this is the first exit option
    • The second target works in the assumption of a continuing trend, so the more aggressive trade exit target will be set at the upper deviation channel

And that’s trading with the linear regression channel. Entering and exiting the market where statistically you know price will react. Go trade it!

Linear Regression Channel Indicator package

$39

Not familiar with “Smart Money” concepts? Want to learn? Each of my products come with a FREE 12 hour Smart Money Video course (in full 1080 HD) by one of my mentors, a VERY valuable education that gives you the trading edge over smart money.

$39 – Purchase the Linear Regression Channel indicator package via Paypal. 

Instant download after payment