Technical analysis studies historical market data to predict future price movement. The analysis involves various methods, such as technical indicators, built using mathematical formulas. Traders can also perform technical analysis by visually analyzing trading charts to identify different price patterns, understand market psychology, and evaluate economic data.
In the trading world, an overwhelming consensus exists among traders that price action on a trading chart reflects all market variables. So, if charts contain all the available market variables, traders need to work on analyzing price action and developing strategies for attempting to predict future price movement. However, carrying out such a task will take work because a trader needs to learn about various technical indicators, price patterns, etc. This article will review a highly effective trading indicator and examine the concept of measured moves. So, let us start with the indicator.
Linear Regression Channel
The Linear Regression Channel represents a three-line technical indicator. It analyzes the upper and lower limits of an ongoing trend. As a statistical tool, the Linear Regression Channel tries to predict future price movement from historical data. Its primary purpose consists of figuring out overbought and oversold zones and identifying potential buy and sell signals based on price volatility.
When you apply this Indicator on a chart, it plots three lines. The middle line stands for the Linear Regression Line. The upper and lower lines represent the upper and lower regression lines. The middle of the Linear Regression Line displays the midpoint of a trend and will generally look like a straight line. Think of the regression line as the equilibrium price where any move above or below the line indicates overzealous buyers or sellers. So when currency prices move above the Linear Regression Line, traders would consider the trend bullish.
Likewise, traders would view currency prices that move below the Linear Regression Line as a bearish sign for a trend. Remember, whenever the forex prices deviate above or below the regression line, you can expect the price to go back toward the Linear Regression Line. The upper and lower regression lines act as support and resistance lines. So, in other words, price action will likely move within the regression channel, where the regression line represents the midpoint of the trend, and the upper and lower regression lines represent the two extreme points.
The linear regression channel uses a standard deviation for a plot. Nearly 68.2% of price action will find containment within the regression channel for a channel plotted using one standard deviation. And for a channel plotted using two standard deviations, nearly 95.4% of the price action will get contained within the regression channel.
Also, traders must remember that two Linear Regression Channels exist, the bullish linear regression channel and the bearish linear regression channel. The price increases in a bullish regression channel, and the channel slopes upwards. The price moves lower in a bearish regression channel, and the channel slopes downwards.
How to Trade using Linear Regression Channel Indicator
Traders can use the Linear Regression Channel Indicator in different ways. As you have learned, the Linear Regression Line means the midpoint of the trend. So traders consider the trend bullish when the price moves above this line. Conversely, the trend takes on a bearish outlook when the price falls below this line. So, using this simple interpretation, one way to trade involves looking at the current price action relative to the regression line, above or below.
You will take a buy entry if price action moves above the Linear Regression Line. Your target profit will likely happen just below the upper regression line, and your stop loss will likely occur near or slightly below the lower regression line. Conversely, you will take a sell entry if price action falls below the Linear Regression Line. Your target profit will likely occur just above the lower support line, and your stop loss will probably happen near or slightly above the upper regression line.
As we know, traders can view the upper and lower regression lines as the two extreme points of the trend. So when the price reaches one of these lines, it will likely go back to the middle line. Another possible way to trade using the linear regression channel involves entering the trade when the price goes near the upper or lower regression line.
So, you will take a buy entry when the price action goes near the lower regression line. Your target profit will occur at or near the middle regression line. The stop loss will occur below the lower regression line. Conversely, you will take a sell entry when price action goes near the upper regression line. Your target profit will likely occur at or near the middle regression line. The stop loss will likely occur just above the upper regression.
These represent two of the most straightforward trading strategies you can adopt using the Linear Regression Channel Indicator. However, trading requires learning a lot more before diving into these concepts. One of the most important things to understand involves the concept of Measured Moves. Traders can use measured moves as a way to analyze the trend direction. And if you can understand the trend direction, the trading results will become more fruitful using the linear regression channel or any other indicator. So let us quickly dive into the concept of measured moves.
Traders can consider measured moves to analyze the price action to figure out the trend direction. Two types of calculated moves exist: the bullish measured move and the bearish measured move. A bullish measured move indicates an uptrend, and the price will make higher highs and higher lows. So when a rising market drops, its low will appear higher than the previous low, and its new high will appear higher than the previous high.
Conversely, a bearish measured move indicates a downtrend. The price will have lower lows and lower highs. So when a falling market rises, its high will appear lower than the previous high, and its low will appear lower than the previous low.
So by just analyzing the bullish and bearish measured moves, you can determine the trend direction. Knowing the trend direction will help you trade confidentially with any indicator, including the Linear Regression Channel. For example, if you identify a bullish measured move, you should also have a bullish regression channel to place a buy trade. Likewise, if you identify a bearish calculated move, the regression channel should also look bearish to take a sell entry.