Linear regression is a currency trading tool which is used to predict what might happen to the currency from past data. It is used to determine when prices are overextended either to the upside or downside and can give traders clues to fair value in an existing trend and alert them to a trend change – Lets look at Linear Regression in more detail and how to incorporate it in your currency trading strategy.

Definition of Linear Regression Indicator LRI

A Linear Regression trendline is a trendline drawn between two points using the least squares fit method. The trendline is displayed in the exact middle of the prices. If you think of this trendline as the "equilibrium" price or fair value price then any move above or below the line indicates a currency which is overbought or oversold.

The Logic of Linear Regression is Simple:

If prices are trending up, you would possibly expect that tomorrows close would be at the level of the previous day with the odds of a higher close. Linear regression is a statistical confirmation of this thought.

Gilbert Raff Linear Regression Channel

Gilbert Raff, developed a channel method which is a popular currency trading tool:

The channel is consists two parallel lines above and below a Linear Regression trendline and the parallel lines are equal distance from the middle line and is plotted as two standard-deviations.

Linear Regression Channels are Used in the Following Way:

The bottom line indicates support and the top channel line indicates resistance. Prices may extend outside of the channel for a short period of time and come back in a strong trend. If however the price remains outside the channel and breaks out a reversal of the prevailing trend will be on the cards. A Linear Regression trend line shows where value exists in relation to the current trend and Linear Regression Channels show the range prices can be expected to deviate from this mid price.

Summary

LRI is a useful tool for trying to postulate the the price for future by taking into consideration past price trends and can be used to enter trading signals within an existing trend and can also be useful for spotting changes in market perception and trend changes.