Linear Regression Indicator (LRI)

Linear Regression Indicator review

Linear Regression Indicator, LRI has been developed by trader Gilbert Raff in 1991 to predict prices as early as possible. This indicator is based on the mathematical concept of regression. Simplistically, the essence of it is that if there is a certain amount of data with the same source and scattered relative to each other, it is possible to determine their interrelation and orientation.

Regression and its indicator

A least square method is applied to construct regression in the two-dimensional graph – one should take the data values for a period and calculate the average line. Price movements are also described by two-dimensional graph and the regression is constructed similarly – the average value of data (value prices) is calculated as a line, and on how the line is inclined, it will be clear what price trend prevails.

The indicator (fig. 1) is constructed in the form of two parallel lines equally spaced from the center line, which are drawn in such a way that they cover all the price values. This forms a channel, wherein the price values are moving near support and resistance lines that are formed by the channel boundaries. This generally gives an adequate picture of the situation in the market and enables us to build practical trading strategies.

Linear Regression Indicator review

Fig.1

LRI is presented in the form of three lines on the price chart: trend line; support line, which is placed over the price at a distance of the maximum price deviation from the center line; line of resistance corresponding to the maximum price deviation from the center line. It is empirically proven that the asset price is generally within the range of this «corridor»; on the other hand, a break of this range against the trend, or sufficiently long location of the price outside the channel shows a change in trend. The linear regression channel indicator can be used on any assets and on any timeframes, and it is most often used to mark the upper and lower boundaries of the market.

Indicator in terminal

A linear regression indicator is a standard one for trading terminals (indicator for Forex). In MT5, it is located in the «Insert» section, in the «Objects» subsection among other «Channels». The indicator is adjusted by the trader to implement a specific strategy. The trader determines two points, and the indicator builds channels based on all price values that are between these two points. If you want to change the calculation interval, you need to double-click on the middle line of a channel and clicking the left mouse button to move the desired point.

In the «Parameters» tab, you can change some coordinates by changing the channel construction time interval, or change the type of indicator lines, or mark the channel displaying period on the chart. You can also change the minor properties of the indicator by clicking on it with the mouse and opening the standard menu. In order to use the indicator with more complex settings, in a colourized version, you need to download it from a third-party source. For MT4 for instance, it may be founded by the following link. Then in the terminal go to the «File» section, go to «Open the data directory» and double-click on the download file. Now the indicator is in the list of user indicators.

Sign in by broker’s terminal, add the Linear Regression indicator to the chart, and see what happens

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LRI application and signals

Traders monitor the movement of prices within the corridor constructed by the indicator. The longer the channel, the stronger it is. Going outside the channel, most likely, portends a change in trend (fig. 2). That trades are made either within the channel or for the breakdown.

LRI application and signals

Fig. 2

As for signals, the trader should pay attention to price indicators regarding three channel lines. If the prices are above the midline, then bulls dominate the market. If prices are below the midline, then bears dominate the market. The further trend direction shows the direction of the channel center line. If the line rises, this indicates an uptrend, and if the center line falls, then a downtrend is formed.

The price movement along the trend from one border of the corridor to another shows an impulse. If the price bounces off the channel border against the trend, this is a pullback, and if it reaches another border, the trend is restored. Particular attention should be paid to situations where the price approaches the boundaries of the indicator channel. If the price bounces from the resistance or support line, then we should wait for the continuation of the trend (fig. 3).

Linear Regression Indicator application and signals

Fig. 3

 

Strategies with Linear Regression Indicator

Two main strategies for working with the linear aggression indicator are obvious and based on LRI signals. As the price approaches an upper boundary of the channel, you can prepare to open a sell position. As the price approaches a lower boundary of the channel, you can prepare to open a buy position. A quite popular strategy option is using two regression channels simultaneously, but with different parameters. Then mutual arrangement of the support and resistance lines, that is, the boundaries of the indicator corridors will be a strong signal.

There is a strategy wherein trading takes place in the corners of the channel of linear regression channels. The strategy is implemented on the hourly timeframe. In this strategy, it is important to determine the reference point from which the channel will be built. The last week preceding the auction shall be taken as the basis.

A regression channel is built according to prices of the past week and the trend direction is determined according to its slope. The basic rule for that strategy is to buy with an uptrend and sell with a downtrend. Orders are rearranged according to the trend, as the regression borders continue for each new bar value. Transactions are closed at the close of the week, moreover, all transactions are closed if the regression channel has a slope of less than 15 degrees. However, the linear regression indicator itself does not provide entry points for trading, moreover, it is not enough for a full-fledged effective strategy for using two LRIs. But an indicator can be the basis of the strategy using other indicators and oscillators. In particular, using of a linear regression indicator with Stochastic (fig. 4) or Fibonacci retracement is deemed to be effective.

Strategies with Linear Regression Indicator

Fig. 4

Most strategies with LRI include determining the leading trend and trading as per trend after a pullback, which require the indicators confirming the signals. In the LRI strategy with Stochastic (5,3,3), sell positions are opened when the regression channel is directed downward, while the moment when the price intersects the trend line of the indicator or when the indicator approaches the lower border of the channel is tracked. At this time Stochastic goes outside the oversold zone above level 20, shows the “ascending cross” pattern, and the main line crosses the signal line from the bottom up.

Sell positions are opened when the regression channel is directed upward, the prices are above the trend line or already approaching the upper boundary of the channel of a linear regression indicator. Stochastic goes outside the overbought zone, shows the “descending cross” pattern and the main line crosses the signal line from top to bottom.

Another trading strategy involves using the Bollinger Bands (fig. 5). As part of this strategy, the main signal will be placement of prices at the lower Bollinger Band and at the same time at the lower border of the regression channel; this is a buy signal. Placement of prices at the upper borders of both the Bollinger indicator and linear regression indicator will be a sell signal.

Strategies with LRI

Fig. 5

LRI is used in strategies supported by Xaser FV and RSI. Xaser FV determines the presence of a trend in the market according to volatility, cutting off flat movements. RSI is one of the most popular oscillators in Forex trading, Relative strength index, which determines the trend strength and the possibility of a reversal. The strategy is implemented on the H4 timeframe, on any currency pair. Linear Regression Indicator is set in a colourized version with the settings period = 40, flat calculation period = 0. RSI is set with a period of 14; closing prices; levels are set at 30, 70, 50.

Purchase conditions are as follows: The Linear Regression was red long enough, but it turned green on a particular bar. At the same time, FV was located at zero level for some time, and then it shows an uptrend for at least 3 bars, being located above zero level. It should be a trend movement, not an adjustment. RSI must be placed above at least level 50 (Forex trading training).

Opposite conditions for a sell position: Linear Regression was green, but it turned red on a particular bar. At the same time, Xaser FV was located at zero level for some time, and then it shows a downtrend for at least 3 bars, being located below zero level. The signals are considered to be stronger if RSI is placed at levels corresponding to the trend direction, 30 and 70, but in this case the number of signals decreases.

 

Summary

The Linear Regression Indicator, LRI enables you to confidently predict the dynamics of prices, and its signals are simple and understandable for novice traders, as well. The linear regression indicator is predetermined in the main trading terminals, while the principle of constructing the indicator channel is objective; it is built based on a clear mathematical formula and therefore it does not depend on the trader, and thereby eliminates the errors of subjective perception. LRI signals are reliable and accurate and, when used properly, can be a key part of the strategy.

Disadvantages of the linear regression indicator include the fact that it redraws the values after the closed bar, perceiving the LRI indicators as a certain average value; you can make a mistake, and this often happens, so you need to understand what this indicator shows and why it is needed.

The linear regression channel indicator redraws its values after each closed bar. This is quite natural and follows from the logic of work, but it can turn out to be a serious drawback for some traders. You need to understand well how and why this tool is used and not try to accept regression as a normal average construction. The linear regression indicator is also characterized by a delay of signals; however, this problem is related to the majority of indicators and oscillators.


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