Linear regression channel trading
But detecting suitable ranges in charts is the main challenge. Firstly ranges tend to be fluid and continually evolving. This article describes a strategy for trading ranges using adaptive linear regression channels. Adaptive linear regression is a statistical method that can solve these problems. It does this by fitting the price to a chain of channels with each being the optimum fit.
This strategy produces good profits for a variety of market conditions and is suited to general use see results. I refined the basic strategy to use trending properties and to avoid trading against significant resistance or support levels. The extended model reduced the number of trades but in doing so increased trade profitability.
A range is simply the upper and lower confines of these price variations. Range trading also known as channel trading, means simply to trade the price between these given boundaries. The philosophy behind this is that history repeats more often than not. And that the highest probability state is that the price will tend to remain within the same confines.
This being until some event causes a shift in market outlook after which a breakout of the channel can occur. The classic picture most have of a range is a horizontal channel. These give rise to either upwards or downwards sloping channels.
They can also be trianglular , wedge shaped or even curved. When I first looked at this I wanted to come up with a strategy that would dynamically adapt to the market and could be easily automated. Standard range finding tools such as those in Metatrader will help you to visually identify ranges. But the problem is these are graphical objects that have to be moved around by hand.
A workable range trading strategy requires a more sophisticated setup. It needs to be able to find ranges without guidance and adapt dynamically as they change over time. To overcome this we created an adaptive linear regression indicator and built a range strategy EA around this. Briefly, standard linear regression is a statistical method for measuring the relationship between two variables. In our case these are price vs.
The linear regression model can tell us for example:. We make this adaptive so that the model parameters are able to change as the price line evolves. The aim of this strategy is to exploit range properties and in doing so produce trades with good risk adjusted returns.
These goals are as follows:.
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The most likely price pivot points occur at or near the range boundaries. But ranges of any size usually have several other key pivot areas. These include the central axis.
In bigger ranges they also include the lines of standard deviation which will mark zones of strong price support and resistance. For example Figure 3 above shows EURGBP on the hourly chart. The two bold lines mark a distance of 1 standard deviation from the central range axis.
These are clearly acting as strong support and resistance. But looking closely you can see that the price is also pivoting at the 0. Standard deviation measures the width or price movement of the range. Basically a range with a high standard deviation is wide, and one with a low standard deviation is narrow. The central axis is the main pivot line of the range. In linear regression, the central axis is also the line of best fit.
Firstly it gives you a baseline to check if the price is trading on the lower side or upper side of the range. For a prominent range, mean reversion becomes important. What this means is that the price will tend to migrate back towards the central axis the mean of the range.
The second reason for identifying the central axis is that it tells you the general direction in which the price is trending. To find the position within the range we set the indicator up to display the distance in standard deviations from the central pivot line. This is the orange line shown in the sub window of Figure 5.
For example when the line is at zero the price is exactly at the central pivot line. Also in the lower window in Figure 5 the green line flags when a grid crossing or bounce occurs and the blue line shows the slope of the range. For this reason, the extent of the range is a valuable input to the trading system. For example, Figure 6 shows a range in GBPUSD on the daily chart D1. The range lasts for days.
Compared to the average of 31 days this is obviously an important structure. Flips between ranges are marked by the range transition line see Figure 6. Figure 7 shows the M30 chart for July of the same year. The lines drawn on the chart are those extended from the range in Figure 6 above. These are known as pitch lines and what the diagram shows is that they have an influence on the price right down to the minute scale. This influence extends long after the original trend has apparently broken.
These can create hidden areas of support and resistance and can work against the current price direction. In the example shown in Figures 6 and 7 the market is trying to break upwards and out of this strong downwards channel.
But the pitch lines from the dominant range in Figure 6 act as strong resistance to upwards progression of the newly forming trend.
The strength of pitch lines reduces the further they are from the central axis of the range. Eventually either the new trend will win over or the original will reassert itself. We used the hourly H1 chart and the minimum range length was set to 50 bars. The back test covers a period of 10 years and the spread was set to 21 points. The tests traded one standard lot per trade and used fixed leverage at 1: Here SD is the price distance in standard deviations from the central axis of the front channel and dx 1 and dx 2 are input parameters.
In the next test we used the pitch lines. We also included the gradient slope of the range as an input — thus avoiding trading against strong trends. To identify pitch lines the strategy uses a second instance of the indicator at the daily scale D1. But the profit factor increased to 1. A free version of the range trade indicator is available here:. How can I get the free version of the indicator you offer here? Can you send me a link or tell me what to do?
The expert takes the output from the indicator and places the trade orders that result from that signal. Once you have a working EA the back testing will be possible.
Please see the downloads page for the free indicator versions and follow the links there. I have the Pro version of this indicator and noticed that sometimes it highlights a range previous to the current one.
Is it because the algorithm finds that the previous range is a better fit to price action even though the current range is still valid? Actually it should be possible to select any range. The indicator will highlight the newest when there are enough bars. Hi I first time visit your blogs i really impressed in fact i am a software programmer but i have been working in financial market last 9 years , i have a sound knowledge market statistics. Unfortunately my education background is not statics and pure math so some time face and unable to solve mathematical expression to generalize, Here i read grid trading ,linear regression channel and martingale.
I would like to know how is the resistance or support found in examples shown in the above? The indicator uses a sampling method to find places where the price is changing direction if you like. Hi Rahul — You mean a general method for identifying any sort of range breakout at all?
Breakouts are highly varied and show in many different contexts.
Having a system that handles all of them is going to be a challenge. One of the best early indicators of a breakout I think is changing volatility as I have talked about in this article and others. I suggest you also look at hedging systems like the straddle trade as well which will give you a pay off if the price moves either way from the break. The link can be found above as well as right at the bottom of this page describing the indicator.
Here it is for convenience: I do a lot of range trading as one of my prefered methods. I mean it is possible for the range to break and then come back into the original track? So in that way you have two ranges which are really just one. How is a check done for this? The range comes to an end when the current price no longer fits within the existing channel. That means having a break out of some sort. So basically the higher this is, the more flexible the range fitting will be.
The tighter it is the less flexibity the range has to grow. This means a higher number of narrow ranges will result. Leave this field empty. Start Here Strategies Technical Learning Downloads. Strategies Nov 19, Range trades can be a very effective strategy and are used widely by technical traders.
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Why Changing Markets are Where the Real Money is Made All serious money managers know that the smart money is made not when the market is stable but when This system can be back-tested easily? Hi Steve, I have the Pro version of this indicator and noticed that sometimes it highlights a range previous to the current one.
My question how can generalize for identifying trade, range breakout. Hello Steve, Thanks for sharing the strategy but where is free version of the indicator?
This is great…… Thanks for your informative insights. Thanks for this great article steve! Leave a Reply Cancel reply. How, when and why to use it: What is it and how Has Anyone Made Money On Zulutrade?
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