How to apply the linear regression channel indicator with crypto trading
Widely available in most charting tools, including TradingView (available on Sparkdex), the linear regression channel is a very popular technical indicator, especially with traders who use channel trading strategies.
Compared to other channel trading techniques, its main advantages are simplicity and precision that help crypto traders find the entry and exit points and future trend direction. As it was developed by Gilbert Raff, the indicator is also known as the Raff Regression Channel.
We will be discussing the structure of this indicator and how to best apply it in crypto trading.
Structure of the indicator: 3 lines on the crypto chart
The linear regression channel consists of three major lines that highlight the upper channel line, the lower channel line, and the middle line of the crypto price trend, also referred to as the linear regression line. The upper channel line connects the highs in the recent trend while the lower channel line does the same, but with the trend lows. The linear regression line refers to the middle of the trend, and it runs in parallel to the upper and the lower lines.
Most charting tools allow you to set parameters for each indicator. In the same way you configure the basic moving average (e.g. 50, 100, 200) indicator, you can set up a linear regression channel as well. The standard “deviation”, which refers to the distance between the linear regression line and two other parallel lines, is +/- 2. If the trend is narrower, deviations can be configured. The normal applicable range is 1 to 2.
In case you opt to set deviation at 2, then you must tolerate up to 5% of the price action to happen outside of the channel i.e. the newly designed channel must contain, within its borders, more than 95% of the price action. The lower you configure the deviations, the lower the tolerance threshold goes i.e. if the deviation is lowered from 2 to 1.5, then the percentage goes down as well to 80% approximately.
In order to incorporate this indicator into your crypto chart, simply select the indicator, (available in most charting tools), and draw the linear regression line from the beginning of the trend to another important point of the trend. Based on set deviation parameters, the two other lines will self-adjust and the indicator will show up on the screen. You can still adjust the channel by moving the linear regression line up or down.
The importance of linear regression channel, from the trading perspective, is two-fold: 1) Upper or lower lines offer trading opportunities and 2) the break of the linear regression channel in a direction opposite to the previous trend (bullish or bearish), signals that the channel is broken as the price action may start going in the opposite direction.
As is the case with all technical indicators, the linear regression channel is best used in combination with other indicators. Always consult other indicators (volume, MA, RSI) to confirm the underlying hypothesis.
There are two types of linear regression channels - bullish and bearish.
Bullish linear regression channel on Bitcoin price chart
The first image of the Bitcoin price chart below shows a sample of the bullish linear regression channel, which understandably refers to bullish trends as the regression channel is upward-sloping. In this particular situation, the deviation is set at 2.
As you can see, the vast majority of the Bitcoin price action is happening within the regression channel, which provides us with a reliable basis for determining the future Bitcoin price direction.
Every time the Bitcoin price touches one of the two extremes, (the upper or the lower line), a trader can expect the price action to experience a change of direction. As part of your crypto trading strategy, A stop loss should be placed above/below the entry as any close above/below the extreme lines of the channel mean that the trade is invalidated. Take profit is usually placed on the opposite side of the channel.
Bearish linear regression channel on a Bitcoin price chart
The bearish linear regression channel is the opposite of the bullish linear regression channel. The channel’s upper and lower lines contain the Bitcoin price action as the slope heads lower.
As seen in the Bitcoin price chart below, there are multiple touches of the channel’s resistance and support lines, with each one of them acting as an opportunity to make a trade.
A clear Bitcoin price indicator, but use it with other technical indicators
A simple, three-line indicator that is widely used in trading, the linear regression channel is often used to identify and trade a certain trend. The upper and lower lines offer clear entry and exit points, as well as stop loss and take profit targets.
In addition, the break of the channel signals that the direction of the trend is changing to opposite to the prevailing trend. Despite the fact that it’s a reliable and a quite straightforward indicator, it’s best used in combination with other technical indicators.