Using Linear Regression in Forex Trading

In forex trading, there are many different ways to analyse the data in a bid to try and accurately predict what the market is likely to do next.

Linear regression is a tool used by many traders, which sounds more complicated than it is, which offers advantages very similar to that of moving averages.

Put simply, linear regression is a statistical analysis tool which looks at both price and time. Both resistance and support levels are shown on the graph, with the slope direction depicting the overall trend of the market.

Regression is a much-used type of statistical analysis and is very commonly seen in trading. In forex, linear regression creates a channel after support and resistance levels are identified which trading will normally stick within. Any burst outside the channel is normally expected to be brief – a prolonged break-through is a sign that the market is about to reverse.

After a midway point is identified, two further lines are created both above and below – a couple of points each way – to create the channel for the range.

As well as helping to identify trends about to develop, linear regression can also help a trader to set both entry and exit points by looking at the boundaries of the channel created. This can give an indication of when the market is reaching the top of its range and the position should be closed.

However, linear regression can be used to create a simple line, rather than a channel if preferred. A linear regression line is created by joining the starting price with an end price, picking the points which create the least deviation throughout the length.

The linear regression line is viewed as the midway point or the `fair price` and is the point which the market is expect to keep moving through. If the current price is above the line, it would suggest a sell strategy and if below the line, a buy strategy.

Linear regression can be used on different time frames, depending on the trades being executed and can help to remove the psychological element from trading. The power of human emotions can be one of the hardest things for traders to overcome and much discipline and self control is required at times.

Because linear regression is based on facts, there is no need to interpret the results – they speak for themselves. This can help to make it easier – when used alongside other technical indicators – to set up entry and exit points, as well as detect trends very soon after they begin.

Linear regression is just one of the tools used by traders to help become more effective and despite its statistical strength, should never be used in isolation to determine a strategy. In order to trade forex profitably it is necessary to select the right mix of charts, tool and indicators; enough to provide sufficient detail for analysis but not too many for the picture to become clouded.