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Linear Regression Channel Trading Strategies in MT4
Technical analysis changes continuously. In the past, traders looked at the market’s basic concepts. Today, the personal computer allows using complicated functions. A linear regression channel is such one. A regression channel and channel trading strategies derived from it are statistical functions traders use to forecast prices.
Furthermore, technical analysis splits in two. One part deals with trading theories. The Elliott Waves Theory is an example.
Another part deals with technical indicators. But, if you ask retail traders what their favorite indicator is, the answers look the same.
Most traders focus on trend indicators and oscillators. As such, you’ll hear about RSI (Relative Strength Index) and Bollinger Bands. They’re the most popular ones.
But technical indicators today go in various other areas. Much more complicated than a simple RSI calculation.
Today, one can use cycle indicators, math operators, math transform indicator…and so on. However, the aim is similar: to forecast future prices. The right future prices.
Statistic functions indicators grew in popularity lately. Especially the most visible ones. A linear regression channel is such an indicator.
Channel trading strategies help trade in the trend directions. All traders want to ride the trend. After all, the trend is your friend. Right?
But, there are various types of channels. Horizontal channels, dynamic ones…only to name a couple.
In this article, we’ll cover:
- What is linear regression?
- How to apply the linear regression channel on a Forex chart
- How to use the regression channel
- Channel trading strategies for the Forex market
- Other statistic function indicators
The aim is to show the power of trading setups derived from statistic function indicators. And, for you to learn their secrets.
It all starts with the linear regression line…
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Introducing the Linear Regression Channel
Traders love a regression channel at least for the following reason:
- It is easier to trade when a channel is present.
- They form an idea about future support and resistance levels.
- It gives great trades both in ranges and trending markets
But what is linear regression? Any introduction to linear regression analysis starts with the linear regression line.
This is a line that best fits prices. What does this mean?
We need several steps to explain the concept.
First, simply open a chart. Any currency pair. Any time frame.
Second, pick a market move. Below is the hourly EURUSD drop from 1.20 to current levels.
Finally, try to find a trend line that connects the highest and the lowest points. But, not any trend line.
The best fit. Or, the one that leaves the least space between price and the actual line. That’s the linear regression line. Pure and simple.
Following the three steps above, the best fit for the EURUSD chart looks like the chart below.
Of course, this is an approximation. Nowadays, any trading platform plots it automatically.
It finds the “perfect fit” with a currency pair in a blink of an eye. But, for the sake of understanding the starting point of a linear regression channel, it was a good example.
Traders use the linear regression line to detect a trend. Deviations from it are great trading signals.
Traders expect prices to be attracted to the line. As such, they buy or sell accordingly.
Such a line is the most simplistic statistic function indicator. However, it is the pillar or a regression channel.
The derived channel trading strategies from a regression channel are one of the most powerful in technical analysis. But, more on this later.
How to Build a Regression Channel
Above, we explained what is a linear regression. But, we used plain English.
Not complicated terms. As such, even the rookie trader to understand.
In reality, a standard linear regression line is the result of a statistical method. Its definition is far more complicated.
It measures two variables. Or, the relationship between two variables.
In any case, a regression channel derives from the linear regression line explained earlier. It has a central axis. And, two parallel lines.
It looks like this.
Note that the regression channel above is bearish. And, the central axis is nothing but the linear regression line.
The other two elements are two parallel lines. That is, parallel to the original regression line.
A proper distance is typically one or two standard deviations above or below the regression line. However, there’s no rule of thumb for it.
Why is this important? Because understanding a linear regression channel leads to powerful channel trading strategies.
Or, understanding how the linear regression channel forms. If the upper and lower channel lines use only one standard deviation, the channel contains 68% of all prices.
In short, it is thinner. On the other hand, if the two lines use two standard deviations, the channel gets thicker.
It’ll have 95% of prices in it. Or, candles.
As such, when the price breaks the linear regression channel, traders use it as a signal. If price spends 95% of the time inside the channel, they trade accordingly.
Remember the holy grail in trading? Price and time.
These are the two variables a standard linear regression uses.
How to Attach a Linear Regression Channel to a Chart
Today, no one calculates the standard deviations manually. Computers do that.
All traders need to do is to find the proper indicator. The one that plots the data automatically.
Unfortunately, the linear regression channel indicator mt4 traders use, doesn’t come with the default settings. Here’s how to solve this issue.
First, search the Internet. Simply Google for the regression channel indicator mt4.
You’ll find it in the first results.
Second, save it on your desktop. This is important!
Third, copy and paste it in the MetaTrader MQL folder, in the Indicators sub folder.
If the MetaTrader was open during this process, close it. By opening it again, the changes will appear.
But, the linear regression channel is a custom, not a default indicator. Therefore, we need to look at Custom indicators to find it.
Finally, simply click and drag it to a chart. The result looks like below.
It shows the regression channel on the EURUSD hourly chart. The black line is the actual linear regression line. You know how to plot it yourself.
And, the two blue lines show the upper and lower linear regression channel lines. But, there’s a trick.
This linear regression channel mt4 indicator considers only fifty candles. As such, it will plot the data for the last fifty hours.
That’s easy to fix. If you need more, simply edit the indicator.
Above is the same EURUSD chart. But, this time we changed the input.
Under bars to count, we switched the variable. From fifty to two-hundred.
The principle is like that of any indicator. Simply change the period to adapt it to your trading needs.
Channel Trading Strategies with the Regression Channel
Now we know how to attach the regression channel indicator to a chart. Obviously, the next step is to learn some channel trading strategies.
Before starting, keep in mind what trading is. It’s a probabilities game.
As such, statistics help. It improves probabilities of finding a good trade.
Why not use statistical indicator, then? A regression channel is perfect for profitable channel trading strategies.
Channel Trading Strategies in Trending Markets
This is the classic way to use a regression channel. Most importantly, it works not only in trending markets.
But, in ranging ones too. What’s different?
The channel’s angle. Ranging markets will end up having an almost horizontal linear regression channel.
However, trending markets will have a rising one (in bullish trends). Or, a falling one (in bearish trends).
If the range or trend holds, the regression line will do its trick. It’ll attract price.
As such, one of the best channel trading strategies is to wait for the price to break. That is, to break above/below the range/trend lines.
That’s the first step. Second, wait for the price to come back into the channel.
Third, go long/short, targeting the regression line. But, always have a stop loss.
Typically, a stop loss must be part of a good risk-reward ratio. In Forex trading, that’s 1:2 or 1:2.5 pips.
Anything below is unacceptable. Anything above is fantastic!
A trade derived from such channel regression strategies has bigger r:r ratios. That is, most of the times.
Let’s use the same EURUSD chart. Moreover, the same two hundred periods linear regression channel.
The price broke above the channel. That’s the first step.
Next, it moves back in. At the close of that candle, traders sell.
The stop loss is set at the previous candle’s highs. That’s the swing high.
And, the take profit, where the linear regression line comes. The outcome blows minds!
The trade had a staggering risk-reward ratio. Keep in mind managing risk is everything in Forex trading.
Channel Trading Strategies That Adapt
The standard interpretation of a linear regression channel should be clear by now. But, how do we know if a trend reverses?
Or, if the price breaks a range for good? Well, if that happens, it won’t be a problem.
After all, there’s a stop loss in place. And, if we keep the money management rules, losing a trade from time to time won’t hurt the trading account.
But what if I tell you that there are ways to know before it happens. We’ll illustrate here one.
The basic one is simple to understand. Traders look at the price action.
Remember how a linear regression channel is built? The prices stay over 95% of the time inside it.
Here’s the key. Reversal channel trading strategies consider the price action.
Or, the ability of price to stay outside the channel. When this happens, the trend reverses. The range will break.
However, variations of a regression channel exist. Visual aids help.
Some channel trading strategies use such visual aids. For example, when the linear regression line changes the trend.
The line is either rising or falling. It won’t say horizontally for long.
Therefore, when it falls, traders sell the breaks higher. When it rises, traders buy.
Regression Channel Indicator on the EURUSD Daily Time Frame
In this type of trading, the usual caveat applies too. The bigger the time frame, the bigger the implications are. Both for the risk, and the reward.
Below is the EURUSD daily chart. The regression channel used here has some visual aids.
Look at the linear regression line. The line in the middle.
Notice something new? It changes colors.
When it rises, it turns blue. When it falls, it is red instead.
That’s a great helping tool. It tells traders what to do.
As such, they buy when the middle line is blue. And sell, when it is red.
That simple? Yep.
From left to right, here’s how to interpret the EURUSD daily chart. First, spot when the linear regression line changes direction.
Easy to do that. Simply wait for it to turn blue.
From this moment, we only want to buy. Or, go long.
And, to do that, we apply the principles described earlier in this article.
Second, wait for the price to break below the lower channel line. That’s the long signal.
Third, wait for a close back into the channel. Finally, go long with a stop loss at the lows.
The take profit may differ. It may be at the linear regression line.
Or, at the upper line of the linear regression channel. Another great risk-reward ratio in both cases!
Is it safe to sell the upper line of the regression channel? Let’s just say it isn’t safe to be long anymore.
Channel Trading Strategies with Fibonacci Golden Ratio
The EURUSD daily example shows the power of channel trading strategies. Such risk-reward ratios are not easy to find.
Other indicators in technical analysis won’t perform that well.
However, a closer look at the rising linear regression channel shows that something is missing. There are few potential trades that miss the entry by a bit.
Look at the previous chart. The price comes to almost breaking below the channel.
However, it bounces. Just before breaking, a sharp move higher follows.
Following strictly the earlier rules don’t make sense.
More exactly, one of the Fibonacci ratios. The most important one: the golden ratio.
Known as the 61.8% retracement, it offers great entries. Channel trading strategies with the Fibonacci golden ratio have slightly different rules.
The graph above shows four potential trades. Other than the one mentioned earlier.
What do traders do? First, they calculate the distance from the linear regression line until the lower channel line.
Next, they find out that 61.8% level. Furthermore, they wait for the price to reach it.
And, they wait for a bullish, green candle. That’s the signal to go long.
We only want to buy here, remember? The linear regression line belongs to a bullish linear regression channel.
Finally, they go long. They place a stop at the lows of the green candle. And target a 1:2 or 1:2.5 risk reward ratio.
Or, the linear regression line. Whichever comes first!
Other Statistic Indicators in Technical Analysis
By now you are aware of the power such indicators have. Because nowadays computers make our life easier, we can calculate virtually anything.
As such, the linear regression channel is only one of various statistic functions we can use. Others are:
- Pearson’s Correlation Coefficient
- Linear Regression Angle
- Standard Deviation
- Time Series Forecast
- The Variance of a financial product
These are only some of the most important ones. Even the linear regression channel has different variations of it.
And, the concepts used in calculating a linear regression changed in time. Traders also use the linear regression intercept indicator. Or, the linear regression slope.
However, the idea is the same. To understand where the price goes.
A regression channel shows everything. As such, traders love it.
Ranges end up giving great trades. A trending environment gives even better ones.
And, channel trading strategies offer one of the best risk-reward ratios.
No one says a stop loss won’t be hit. But, most of the times it doesn’t.
Moreover, when it doesn’t, the resulting trade has bigger than average rewards. That’s all that matter for the trading account to grow.
If trading is a game of probabilities, then using statistic functions indicators makes sense. After all, we want to trade on the right side of the market.
What if there’s a way to find out which side is the right one? Won’t you trade in that direction?
This article proved, beyond doubt two things:
- Super-sized risk-reward ratios are a reality in Forex trading. Not a myth.
- A linear regression channel is the tool to get them.
Rest depends on each trader. Other factors intervene.
Greed and fear, for instance. In short, human nature.
But, if you bothered making a plan, stick to it. Why trading randomly?
Successful Forex traders don’t know where the market goes. They have an educated guess.
That’s all that is. Statistically, the price should go there. Hence, they’ll stand better chances to win.
That’s trading with the linear regression channel. Entering and exiting the market where, statistically, you know the price will react.
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Linear Regression Line
Linear regression, when used in the context of technical analysis, is a method by which to determine the prevailing trend of the past X number of periods.
Unlike a moving average, which is curved and continually molded to conform to a particular transformation of price over the data range specified, a linear regression line is, as the name suggests, linear. It takes a certain number of user-defined periods and plots a linear line that best fits the general trend.
To clarify, it is not simply taking the current price and the price from X number of periods ago and drawing a line between the two. The activity in between the two points is every bit as critical.
For example, in the particular 50-day period in the S&P 500 below, the net gain of the market is positive. Yet the linear regression line is negatively sloped. This has to do with a strong down-move over the course of this period. Most forms of linear regression are based on the mean or average, which makes it sensitive to outliers. Since the mean price over this period was below where it currently stands, the linear regression line is negatively sloped.
The shape of the linear regression line is simply designed to represent yet another way to track the market’s trend.
Conceptually, linear regression implies that it can predict how an output will change based on an input. In this case, it’s simply using previous price data to predict the general trend of future price data. This is, of course, a naïve assumption, but trends have a way of persisting over time until the information embedded in a market materially changes.
If we set the linear regression line to a 100-day period, we see the line markedly take a different shape:
For trend traders, this might present confusing signals to have the 50-day and 100-day regression lines be so profoundly different. Which one is more “correct”?
First, it is never recommended to use any given indicator in isolation. Being in buy/long trades when a X-period regression line is pointing up and sell/short trades when a X-period regression line is pointing down will not be a profitable trading strategy.
It should ideally be made to fit your trading timeframe. Those who trade with the intention of holding positions over the course of years might apply a 200-day linear regression line to a daily chart. Someone who holds positions minutes or hours might apply a 20-period linear regression line to a 5-minute chart.
If paired with a moving average, it would make sense to have them both be the same period for equal comparison’s sake. For example, here’s the linear regression line paired with a 50-period simple moving average (SMA).
If you’re a trend follower and trust the signals that the linear regression line and SMA give you on these particular periods, you’d probably pass on anything trend-related.
Examples of the Linear Regression Line Within a Broader System
The linear regression line can be relevant when identifying the trend within a larger trading system.
Many trading systems are based on the premise that once all indicators match up, a trade signal is thereby given in a particular direction.
For example, we could invent a trading system that involves trade entries based on trading with the trend according to a 100-period linear regression line and 100-period moving average.
With respect to price reversals, we can use Keltner channels. For Keltner channels, we’ll use 20-period bands and a 3x multiple of the average true range.
- Trade only with the trend, meaning both the 100-period linear regression line and 100-period moving average are in agreement.
- When the above rule is true, take long trades when price hits the bottom band of the Keltner channel. Likewise, when both the linear regression line and moving average are in agreement in a downtrending market, a touch of the upper band of the Keltner channel would be a signal to go short.
- To exit a trade, we can use either a shift in the trend – i.e., the slope of either the linear regression line or moving average changes (opposite the direction of the trade) – or a touch of the linear regression line.
Also note that backtesting this strategy is particular difficult given that the linear regression line changes shape continually. How and where it’s displayed on the chart currently is purely dependent on the market at the current moment, not where it was at some point in the past. The best you can do is infer on the basis of knowing how linear regression lines are made to fit a particular data set.
Let’s see how this would have worked out on a daily chart of WTI crude oil:
Here we have one or two trade signals (shown through the two green arrows), depending on whether you’re willing to take the same setup more than once. We see both trend confirmation tools pointing up.
We ignore price’s touch of the top band on the way up as those trades would have gone opposite the trend. But we do get a touch of the bottom band twice. This presented a solid setup to take a long trade in the direction of the up-trend of the market.
Some trader’s might take just the initial touch and ignore the subsequent touch since it’s fundamentally the same trade idea. Moreover, it might constitute “doubling down” on a position and could make one’s book (i.e., current set of live/open trades) more concentrated and dependent on a certain outcome to profit.
The trade was exited upon a touch of the linear regression line (white line).
Let’s apply it to a daily chart of the USD/SEK (US dollar versus the Swedish krona).
With this currency pair in a downtrend, we see confluence with a down-sloping 100-period linear regression line, down-sloping SMA, and touch of the upper band on the Keltner channel.
Based on the chart and our rules stipulated above, this trade would still be open if our close signal is a touch of the linear regression line. However, it would be closed if we were more flexible and extended it to a touch of the SMA or if we added a center line in the Keltner channel.
A linear regression line is an easy-to-read way of obtaining the general direction of price over a past specified period. Unlike a moving average, which bends to conform to its weighting input, a linear regression line works to best fit data into a straight line.
Linear regression lines will be more dependent on the period of the timeframe considered relative to moving averages. It’s rare that there will be wide dispersions in the general gradation of a moving average between, for example, 50 and 100 periods. There can, however, be a big difference between a 50-period linear regression line and a 100-period regression line.
Note the difference below.
50-period linear regression line + 50-period SMA
100-period linear regression line + 100-period SMA
A linear regression line should not be used a system itself. Rather it should be used in the context of a larger trading system – mechanical or otherwise – that uses other technical indicators, price, candlestick patterns, support and resistance levels, and/or fundamental analysis to improve the accuracy of trading decisions.
Forex Training Group
Channels are an important component of technical analysis. There are quite a few types of channel trading techniques that can be applied. Some of these include Fibonacci Channel, Andrews Pitchfork, and the Keltner Channel. In today’s lesson, we will discuss another important type of trading channel known as the Linear Regression Channel. We will discuss the structure of the Linear Regression channel and some best practices for applying it to your price charts to improve your analysis.
What is a Linear Regression Channel
The Linear Regression Channel is a three-line technical indicator, which outlines the high, the low, and the middle of a trend or price move being analyzed. The indicator was developed by Gilbert Raff, and is often referred to as the Raff Regression Channel. The Linear Regression indicator is typically used to analyze the upper and lower limits of an existing trend. It helps traders to find optimal entry and exit points during price tendencies on the chart.
Structure of the Linear Regression Channel Indicator
The Linear Regression Channel indicator consists of three parallel lines – the upper line, lower line and the median line.
Upper Linear Regression Line
The upper Linear Regression Channel line marks the tops of a trend. It is built by going through the most projecting top on the chart. The lower and median line will be parallel to this upper line.
Lower Linear Regression Line
The lower Linear Regression Channel line marks the bottoms of a trend. It is built by going through the most projecting bottom on the chart. The upper and median line will be parallel to this lower line.
Median Linear Regression Line
The median line is the base of the Linear Regression Channel indicator. It draws the midpoint of the trend. The upper and lower lines are evenly distanced from this middle line.
Above you can see the Linear Regression Channel indicator and its components. The black arrows show the most projecting top and bottom in the trend. The three blue lines point out the upper, lower, and median line of the indicator.
Using Linear Regression on a Price Chart
The Linear Regression Channel can be used to time your entries and exits more effectively. Each time you see a price interaction with the upper or lower line of the drawn indicator, you should become aware that the price action may be due for a change in direction. Also, when the median line gets broken in the direction of the trend, this means that a current impulse wave is likely forming, which could provide for a trend continuation signal.
Another important signal that comes from regression trend analysis is the eventual break out from the channel. When the price breaks the Linear Regression channel in the direction opposite to the prevailing trend, this gives a strong signal that the regression channel break will create a significant turning point in the price action.
Types of Linear Regression Channels
There are two types of Linear Regression channels, depending on the direction of the trend – the bullish and the bearish linear Regression channels. These two types of regression channels are defined based on the Linear Regression slope.
Bullish Linear Regression Channel
The bullish Linear Regression Channel refers to bullish trends. In this case, the price is increasing and the slope of the Linear Regression is upwards.
Above you see a bullish Linear Regression Channel. The trend is bullish and the indicator is upward sloping.
Bearish Linear Regression Channel
The bearish Linear Regression Channel is opposite to the bullish Linear Regression and it refers to bearish trends. For the bearish scenario, the price is decreasing and the slope of the Linear Regression is downwards.
This is the bearish Linear Regression indicator. The trend is bearish which means that the slope of the linear regression line is downward sloping.
MT4 Regression Channel Indicator
As with any type of technical study that you use, it is useful to know the basics of how an indicator or study is calculated.
But in any case, you will find the Regression Channel indicator built into most Forex trading platforms including MetaTrader 4. We will now take a look at how to add this indicator to your MT4 platform and how to build a price chart using this channeling technique.
Adding the Linear Regression Indicator
First, you need to select the indicator from the menu of the MT4 platform. You can do this by going to the top of the MT4 window, then clicking on Insert > Channels > Linear Regression. Now you have selected the indicator and it is activated as a drawing tool for your mouse cursor.
Drawing the Linear Regression Channel
Now you need to actually draw the Linear Regression Channel. Simply select the beginning of a trend and stretch the indicator to another crucial point of the trend. The three lines of the indicators will self-adjust depending on the most projective top and bottom of the trend. Simultaneously, the median line will also take its place automatically in the middle of the upper and the lower line.
Linear Regression Channel Analysis
The primary form of Linear Regression Channel analysis involves watching for price interactions with the three lines that compose the regression indicator. Each time that the price interacts with the upper or the lower line, we should expect to see a potential turning point on the chart. For swing traders, this means that you want to enter after a retracement in the direction of the trend, and exit when price approaches the opposite end of the channel.
The chart above illustrates a bullish Linear Regression Channel. The black arrows point to channel extremes where the price action is well contained by the indicator.
The second bottom on the lower line of the indicator should be used to enter a long trade. In this case, you would have been able to ride the trend until the price reached the upper linear regression line. This is shown by the top arrow.
The price reverses afterwards as it breaks the lower line. This creates a breakout opportunity on the chart, meaning that the trend is now likely to reverse. We did see price move back up again to test the previous top but failed to take it out. At the same time, we see a Pin Bar formation, followed by a second breakout below the Regression line.
Depending on where you had placed your stop loss, your first breakout trade may or may not have been profitable, however, on the second breakout, if you had placed a sell order below the breakout point and a stop loss above the Pin Bar high, it should have resulted in a profitable trade.
Forex Linear Regression Trading System
Now let’s discuss how you can create a rule based Forex Linear Regression trading system, which will help you to plan out and execute your trades more effectively.
Entering a Linear Regression Trade
Let’s take the case for a bullish price trend, which would have an upward sloping channel.
To enter a Linear Regression trade, you should buy the Forex pair on the second bounce off the lower line of the indicator. The second bottom is used to confirm the presence of the trend. Since the bottoms are increasing, a trend is probably emerging on the chart. Therefore, we would look to buy the currency pair at this time, attempting to catch an upcoming bullish impulse.
Opening a bearish Linear Regression trade works the same way, but in reverse fashion.
Stop Loss on a Linear Regression Trade
You should always use a stop loss order when trading a Linear Regression based strategy. If you are trading a bullish Linear Regression setup, the stop loss order should be placed below the swing low created by the price bounce from the lower line of the indicator.
Conversely, if you are trading a bearish Linear Regression, your stop loss order should be placed above the swing high created by the price bounce from the upper line of the indicator.
Linear Regression Take Profit Rules
You have two options to take profit using the Linear Regression study. The first option is to hold your trade until the price action reaches the opposite Linear Regression level, which we discussed in an earlier example.
You can apply another take profit approach for your Linear Regression trade as well. This would be to hold the trade until the price action breaks the median line in the opposite direction of the prevailing trend. This means that if you trade long, you could hold the trade until the price extends above the median line, and breaks it downwards. If you are shorting, then you could close the trade when the price goes below the median line and then breaks it upwards.
Of course, none of the Linear Regression trades should be held if the price action breaks the channel in the direction opposite to the general tendency. If a breakout in the Linear Regression Channel occurs, then you should close the trade, and possibly look to position counter trend.
Bullish Linear Regression Channel Trading Example
Let’s now take a look at a few examples on the chart based on our stated linear regression rules. We will start with a bullish Linear Regression chart example shown below.
This is the hourly chart of the EUR/USD Forex pair for Oct 21-29, 2020. The image shows a bullish Linear Regression Channel.
Take a look at the two numbered points on the chart. We use these two bottoms to build the indicator. When the price bounces a second time, we identify the second bottom, we build the indicator and look to open a long trade. Then we should place a stop loss order right below the new low.
The price increases through the median line, creates a swing in the median area and then expands to the upper level of the indicator. This is when we should look close your trade.
The second trade comes when the price action reaches the lower level of the Regression Channel. The bullish candle which closes after the interaction with the lower level marks the bounce from the line. Therefore, you look to buy again placing a stop loss order below the created bottom.
As you can see, the price action increases rapidly and reaches the upper level of the Linear Regression indicator. You would look to close the trade when the price approaches the upper line.
The price returns to the lower line of the indicator afterwards. Then we see another bounce from the lower level. We repeat the process for a third time. We buy the EURUSD pair and we place a stop loss order below the created bottom. Then we hold until the price reaches the upper level of the indicator.
The next time the price returns to the lower level it creates a breakout opportunity which accounts for a significant decrease in price.
Bearish Linear Regression Channel Trading Example
Now let’s shift our attention to a Bearish Linear Regression Channel trading example. However, this time we will take the alternative take profit approach where we hold the trade until the price action breaks the median line from the side which is opposite to the trend.
The image above is the 4 hour chart of the EUR/USD for May-June, 2020. This time we approach a bearish Linear Regression trading example.
Take note of the two numbered points that mark the two bases of the Regression channel. When the price bounces a second time, you could build the indicator and look to short the EUR/USD Forex pair. Then you need to secure your trade with a stop loss order above the created top. This is shown with the red horizontal line.
Notice how the price decreases afterwards and moves below the median line. For this trade management exit, we would look to close the trade when the price breaks the median line in the bullish direction from below.
Soon afterwards, the price returns back to the upper level of the bearish Linear Regression channel. When you see the new bearish bounce from the line, you should look to short the EUR/USD pair again, placing a stop loss order above the created top.
The price quickly moves below the median line and touches the lower level. Our exit strategy states that we need to see the price switch back above the median line in order to close the trade. Therefore, we hold until this happens.
The third return to the upper line leads to another bearish bounce, which is another short signal on the chart. Again, you would look to sell the EUR/USD placing a stop loss as shown on the image.
In this case, the price action declines below the median line in just a few periods. As you can see, the price breaks the median line upwards and soon after breaches the upper level of the bearish Linear Regression Channel as well.
In the first two short trades, we would have generated more profit if we have waited until the opposite level was reached. However, in the third trade, where the price did not reach the opposite level and a complete reversal occurred on the chart, the median line exit proved to be better. In this third case the median line saved us from a losing trade.
The trade exit strategy that you employ with a linear regression channel will be based on your own preference and comfort level. Unfortunately, there is no best solution for every case.
- The Linear Regression Channel a.k.a. Raff Regression Channel is a three line channel indicator developed by Gilbert Raff.
- This indicator provides a framework for identifying and trading within a trend.
- Using the Linear Regression Channel indicator helps traders better time their entries and exits.
- The Linear Regression Channel consists of three lines, which are evenly distanced and parallel:
- Upper Line – marks the upper boundary of a trend
- Lower Line – marks the lower boundary of a trend
- Median Line – marks the midpoint of the trend
- There are two types of Linear Regression Channels depending on the trend direction and respective slope of the indicator:
- Bullish Linear Regression Channel – plotted during bullish trends and is upward sloping.
- Bearish Linear Regression Channel – plotted during bearish trends and is downward sloping.
- The Linear Regression Channel is built in the MetaTrader4 platform. To add the indicator to your chart you should perform the following steps:
- Go to the top menu of the MT4 platform and click on Insert > Channels > Linear Regression
- Then select the beginning of a trend and stretch the indicator along the tendency.
- Linear Regression Trading Strategy (bullish):
- Enter a trade when the price bounces from the lower level of the Regression Channel.
- Put a stop loss order below the bottom created prior to the bounce.
- You would hold the trade until one of the following conditions is met:
- The price reaches the Upper Linear Regression level.
- The price switches above the median line and then breaks it downwards.
- The price completely breaks the Linear Regression Channel in the direction opposite to the trend.
- Apply the strategy in the opposite direction for bearish Linear Regression Channel trades.
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