What are regression trend channels and how to apply them in order to enter and exit Forex trades?
Recently one of our members posed a question about what regression trend channels are and how to use them. It is an easy topic to grasp, but important for technical analysis of data. And in this blog I will break it down to you.
First let me say that price channels can be very useful when it comes to finding a high probability entry or exit point for your trades. They can also offer an objective way to manage your trades by alerting us to potential changes in market sentiment when price trends change. As with all technical tools, price channels can assist us in finding ‘where’ to enter a trade. While our fundamental analysis only tells us the ‘why’.
Price channels are a fairly simple tool used to show the overall direction of a currency during a specific price cycle or duration of time. You can utilize them to follow the overall trend, or determine when a trend or trend cycle has come to an end. You have probably seen these channels on charts before. They are a very common technical study.
Regression Trend Channels
There are several different types of trend channels you can apply. But today we will focus specifically on Regression Channels. Regression channels draw an upper and lower channel by using a standard deviation of the prices. This is similar to Bollinger Bands, which draw bands using standard deviations of a moving average. However, instead of a moving average, the regression channel uses a linear regression line based on the user defined price cycle.
We start by choosing the two extreme points (current high and low) of the cycle we are analyzing. After we select these two points we will see a median line, upper bound channel line, and lower bound channel line as seen below.
Application of regression trend channels
The object of any trader is to buy low and sell high within a trend cycle. So when price is moving toward the lower bound of an up trending channel it can give us a potential level to buy the currency pair if the trade is still backed by solid fundamentals.
The same is true when price is approaching the upper bound of a down trending channel. It can give us a higher probability sell area. These levels are even more powerful when used in confluence with other levels of support and resistance such as swing highs / lows, pivots, and Fibonacci levels.
Another way to use the regression channel is to determine when a “pullback” or “corrective cycle” ends and the fundamental trend is likely to resume as seen in the example below. After a breakout we often see a retest of the channel that we can use for entry. It is very similar to trend lines.
You can also draw channels within channels. Start by drawing your trend channel on the higher degree time frame which should line up with your overall fundamental view of the currency pair. Then move down to the smaller degree time frame to draw the channels on the “pullback” or “corrective” cycles, as seen in the example below.
In summary, Regression Channels can give us an objective technical approach for entries, stop loses, and even profit targets based on the overall fundamental view. As with any technical approach it is better to apply them after you have determined the fundamental direction of a currency pair.
So hopefully this post has helped you understand a little better how you can apply regression channels to your trading. And I really want to encourage you, so please put your questions and comments below so that I can understand exactly what trading strategies you would like to know more about!