What is Linear Regression?
Similarly to moving averages, the linear regression (LR) indicator is used to identify trends. The LR indicator analyses two variables to define a single relationship. This refers to the variables of time and price of a chart analysis.
Advantages of a Linear Regression Indicator
The linear regression indicator has a high, low and middle line referring to the price move. Traders can use the linear regression indicator to analyse any upper or lower limits of an existing trend and find any optimal entry and exit points of a currency pair.
Consisting of three lines, the higher linear regression line marks the top of a trend. It is created by going through the most projecting top of the chart. The following lower and middle lines are parallel to this higher line. Likewise with the lower linear regression line, it is the most projecting bottom of the chart, and the higher and middle linear lines are parallel. The middle line is the base of the linear regression indicator, and identifies the midpoint of a trend.
A trader can use the linear regression indicator to their advantage by timing their entries and exits more accurately. Whenever there is a price interaction between the higher or lower linear regression line, it should indicate that there is going to be a change in direction for the currency pair. Another advantage is when the middle line is broken in the direction of the trend, indicative of a current impulse wave likely to form which shows a possible trend continuation signal.
Other ways of analysing the linear regression indicator is to watch for any eventual breakouts from the channel. When the price breaks the linear regression lines in a direction that is opposite to the prevailing trend, it gives a strong indication that the regression break will then create an important turning point for the currency pair.
When using the linear regression indicator, there will be two types of LR channels depending on the direction of a currency pair.
A bullish currency pair will have an upward trend, as seen below with the USD/CHF pair.
While a bearish currency pair will have a downward trend, as seen below with the AUD/USD pair.