For crypto traders that prefer to use channel trading strategies, the Linear Regression Channel is one of the most popular indicators. The main advantages are the precision and simplicity it offers for traders to find entry and exit points, as well as the direction of the trend moving forward.
A closer look at the Linear Regression Channel Indicator
There are three lines that make up the Linear Regression Channel: the upper, lower and middle line. The upper line connects all the highs in the recent price trend, and the lower trend does the same for the lows. The middle line, also referred to as the regression line, refers to the middle of the price trend and runs in parallel with the other 2 lines.
Similar to how you set up a momentum indicator, you need to set parameters around the Channel Regression Channel Indicator. The standard “deviation”, which refers to the distance between the linear regression line and two other parallel lines, is +/- 2. The narrower you set the channels, the lower your tolerance threshold goes.
If you set the deviation at 2, then you should see 95% of the price action happening within the channel, and 5% outside of the channel. When you lower the deviation say to 1.5, the percentages change to approximately 80% within and 20% without the channel.
Drawing a line in the trend
To apply the Linear Regression Channel, select it from the charting tool menu and draw the middle line from the beginning of the trend to the final point of interest. The two other lines will self-adjust based on the parameters for the set deviation.
The upper and lower lines on the price chart indicate trading opportunities. The break of the linear regression channel in a direction opposite to the previous trend (bullish or bearish), signals that the channel is broken as the price action may start going in the opposite direction.
There are two types of linear regression channels – bullish and bearish. Let’s look at two different moments in the BTC/USD market to show how this indicator works.
Reading the signals of a Bullish Linear Regression Channel
In the Bitcoin price chart below, we see an example of the bullish linear regression channel sloping upwards. The deviation is set at 2, and with 95% of the price action happening within the channel, we have a reliable basis for determining the future direction of the BTC price trend.
Whenever the BTC price touches the upper or lower line, you can expect the price action to change direction. You should place a stop loss order above and below the entry as any close above or below the extreme lines of the channel invalidates the indicator. Usually, take profit is places on the opposite side of the channel.
The signals of a Bearish Linear Regression Channel
As you might expect, the bearish linear regression channel is the opposite of the bullish linear regression channel. The same rules apply to deviation and tolerance threshold, but now the trend slopes downwards.
Each time the BTC price touches the Channel’s upper resistance and lower support levels, it presents trading opportunities for crypto traders that know how to seize them.
As you can see from these two examples, the indicator is easy to set up and generates simple and reliable signals. However, it’s always best to use other technical indicators to further test your hypotheses.