Linear regression is an under used tool available in most platforms. It may lack many of the bells and whistles that other indicators have but it neatly shows trend direction and strength and can be used to predict how far the trend will safely move.
The rules of the strategy are simple:
- Use the standard deviation channel tool to draw a linear regression line on your chart up to the most recent closed bar. Use a period that makes some sense for establishing a trend. On a 4 hour chart I use 18 periods which is 3 days, enough for a trend to establish.
- Do the same on the next 2 higher timeframes but adjust the period to also match something sensible for those timeframes. On a daily chart I use a period of 10, or 2 weeks and on a weekly chart I use a period of 5 to ensure I capture a full reporting cycle.
- The slope of the linear regression line indicates the prevailing trend. A down sloping line inidcates a bear trend and an upward sloping line indicates a bull trend.
- Only trade if all 3 timeframes show the same trend direction
- On the 4 hour chart (or other time if you are not trading 4 hour) wait until the price for the just closed bar touches the edge of the standard deviation channel away from the direction of the trend. That is touches the upper line for a downward trend or the lower line for an upward trend.
- Place a sell stop or buy stop at the end of the linear regression line. For a sell trade place a stop loss at the upper line of the channel and take profit at the lower line of the channel. For a buy trade place a stop loss at the lower line of the channel and a take profit at the upper line of the channel.
- Avoid trading near news events.
- Check the recent changes in slope of the linear regression line and the current slope. If the slope is too shallow the trend may be about to reverse. If the trend is too steep it may not be sustainable. If the recent slope of the line has been increasing the trend could be strengthening and if the slope has been flattening the trend could be weakening.
- After the order is placed watch for any changing conditions that may make the trade invalid.
The description is also in this video.
You can download the indicators referenced in the video here
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