In this guide to understanding Linear Regression Curves, we’ll show you what this chart looks like, what it’s used for, teach you how to interpret it, and discuss variations on ways to use it.
What Is the Linear Regression Curve?
The Linear Regression Curve plots a line that best fits the prices specified over a user-defined time period.
Think of the Linear Regression Curve as numerous lines, but both extreme ends of the lines are hidden, while the center portion is shown and is connected to other center portions of lines.
What Is the Linear Regression Curve Used For?
The Linear Regression Curve is used mainly to identify trend direction and might sometimes be used to generate buy and sell signals.
The chart of the S&P 500 E-mini Futures contract shows a 9-day Linear Regression Curve:
Understanding Linear Regression Curves
Traders might view the Linear Regression curve as the fair value for the stock, future, or forex currency pair, and any deviations from the curve as buy and sell opportunities.
Generally, when price deviates a certain percentage or number of points below the Linear Regression Curve, then a trader might buy, thinking that price will revert back to fair value, which is thought to be the Linear Regression Curve.
In a similar manner, when price moves above the Linear Regression Curve by a trader specified percentage or point value, then the trader might sell, believing that price will return back to the Linear Regression Curve.
Since the Linear Regression Curve is great at identifying trend direction, other variations of these buy and sell signals could be employed.
- If price is trending higher, a trader might only take buy signals when price deviated below the curve.
- Likewise, during a downtrend, a trader might only take sell signals, not wanting to fight the prevailing trend downward.
Arguably the most popular usage of the Linear Regression concept is the Linear Regression Channel, often used by large institutions.
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Below we answer some common questions about Linear Regression Curve indicators.
What’s the difference between the Linear Regression Curve and a Moving Average?
Although these indicators may look similar, they are calculated differently. A simple moving average chart calculates the average of closing prices within the chosen period. The linear regression curve instead calculates a linear regression line between each date in the period and joins them together over time. Although they are calculated differently, they similarly illuminate price trends over time.
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