The Linear Regression Indicator is a simple indicator included in the basic equipment of MT4 and MT5 trading terminals.
The indicator builds a channel on the chart of the price of the trading instrument. Despite the simplicity, most Forex traders do not use it when trading, but in vain. But first things first.
Applying the Linear Regression Indicator to the graph is very simple. If you have MT5 – open the Insert-Objects-Channels-Regression channel menu.
Once again, this is a very simple indicator in its essence, the only thing that is really difficult in it is the formula for calculating it, built on the basis of regression analysis. You do not need to understand it, because it is not necessary for practical application in trade.
Appearance of the indicator Linear Regression
The indicator is three lines. The central line is built on the basis of regression analysis, and the other two (the canal boundaries) are equally remote from and parallel to it. In fact, this indicator is a tool for graphical analysis, therefore it does not have additional parameters to be set, but is simply constructed according to a formula. The basic idea is that you can take any gap on the price chart and build the corresponding channel according to the values of the candles. The channel is being built at the closing price of the candles.
Mathematical Principles in Linear Regression
So, what’s the point? It is proved that if the set of points is located on the plane (in our case it is the prices of the trading instrument), then we can build on them only one straight line, where each of its points will be at the minimum distance from the sum of the squares of the distances of the original points.
This straight line is constructed from the simple linear equation y = ax + b. It is for this reason that the channel is called the linear regression channel. The boundaries of the channel are at the maximum average deviation from the price.
Signals of the Linear Regression indicator and trading tactics
You already guessed, the Linear Regression Indicator is a trend indicator. Its main task is to point to the current trend. Its direction and strength, as well as signaling about market corrections.
We understand the direction by analyzing the slope of the indicator’s midline. If the indicator is directed upwards – the trend is positive, on the contrary, negative.
The current strength of the movement is indicated by the location of prices in the channel. If the prices for the three candles touch the upper border of the channel, there is a strong upward movement. And vice versa, down.
On the correction in the market, may indicate a rebound from the border of the channel and a reversal of the price movement against the main direction. At the same time, when the opposite border of the channel is reached, the movement, as a rule, resumes.
But, as in the case of other indicators, you can not use only these signals to enter the market. Always need confirmation.
Conditions for opening a position
Trend ascending. The middle line of the indicator is growing.
The price approached the lower border of the channel and punched it.
We put the pending order for the purchase higher by 2 points from the maximum price of the candle, at which the breakdown of the channel took place.
If, within four candles, the order does not work, we delete it. As you can see in the picture, the order was opened on the third candle after the signal.
Stop Loss set lower by five points from the previous minimum value.
We close the transaction with profit, as soon as the price closes above the upper border of the channel.
For a deal to sell similar conditions, but vice versa.
Note. For a more stable trade, use clear rules for managing capital in the work and, as mentioned above, confirming signals from other indicators.