This week we are going to discuss a subordinate indicator that many traders do not take advantage of but should.
The Linear Regression Line subordinate indicator can be an extremely useful indicator for traders who struggle with angle of ascent or descent analysis and identifying topping, bottoming, and early stages of sideways patterns.
TechniTrader® employs 2 Linear Regression Lines on its chart.
These are designed to be used with short term trading styles such as intraday, day, swing, and position trading. They are not as useful for intermediate or long term analysis.
The LRL is applied directly onto the candlestick chart so that it is easy to read and interpret.
Chart 1The Linear Regression line indicator is a totally different way to study price action, trends, trendline patterns, etc.
Where the Moving Average smooths the price action to create a line that floats above, below, or in the middle of the candlesticks depending upon whether price is moving up, moving down or moving sideways, the Linear Regression Line is a straight line from point A to point B. The length of the line is dependent upon the period settings. The line always starts at the current day and moves backward X number of days.
In this instance, we are using a 35/75 LRL. The reason we use these periods is that it includes slightly more than 1 month of data, and slightly more than 3 months of data, which is ideal for short term trading.
The Moving Average below shows trend but lags price action. All moving averages, regardless of whether they are simple, front-weighted, weighted, or exponential, lag to some degree.
The Linear Regression Lines do not lag but reflect the current price angles that are present at that moment in time.
Chart 2When a moving average is in the center of the candles or price, this means the moving average has failed because the action is sideways. When they are working properly, Moving Averages are either above for a downtrending stock, or below for an uptrending stocks. When the moving average is in the middle of the candles, it has formed a failure pattern, meaning it is no longer defining uptrends or downtrends. Moving averages are basically worthless during sideways price action.
The Linear Regression lines however are very useful in defining how price is behaving in sideways patterns.
On the chart below, the longer regression line is telling us that the angle of ascent is heading up at a reasonable angle. The angle is clearly defined and easy to interpret. There is no indication yet of a severe angle.
The shorter Linear Regression Line has dropped below the longer one. This is a weakening of the shorter term trend. What this tells us immediately is that the price has shifted sideways or is about to shift sideways. The shorter Linear Regression Line shows us quickly and decisively that the shorter term price action is not keeping up with the longer Linear Regression line price.
Chart 3On the Chart below, the short linear regression line is above the longer regression line indicating that the most recent price action is gaining and moving up despite the fact that the candles look quite sideways. Price is moving up. The longer regression line shows that the price over the past couple of months has been quite flat and sideways. This early tip up of the shorter regression line helps identify quickly and easily that price is starting to move out of the sideways pattern.
Chart 4If you have never used linear regression lines, try them out. The LRLs give a different view and perspective than moving averages and can help traders decipher more complicated or ambiguous candlestick price patterns sooner.
Since Linear Regression Lines do not smooth or average price, the stark view tends to lead price.
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
©2012 Decisions Unlimited, Inc.
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