Auto Regression Channels

Auto regression channels are a type of Linear Regression Line with channels set at one or more standard deviations from the linear regression line. A movement of the stock price above the upper channel typically signals the stock price is overbought. While movements below the lower channel typically signal an oversold status.

As the name implies, Auto Regression Channels are automatically determined by the charting software using pivot points. The stronger the pivot points the more likely you are to get a long-term linear regression line. The weaker the pivot point, the more likely you are to get a short-term linear regression line.

The linear regression line is often called the line of “best fit” because the trend line has the smallest overall gap between prices and the line itself versus any other line that could be drawn on the graph. Keep in mind, with an Auto Regression the charting software only analyzes the data from the selected pivot point rather than the entire timeframe selected on the chart.

Auto Regression Channels in Practice

Upon submitting any setting adjustments the charting service will graph the linear regression line (black) with the upper channel (blue) and lower channel (red) lines at your desired level of deviation. The default two standard deviation lines would represent 68% of the expected price range for the stock price. Ideal entry and exit points would be areas near the lower and upper channel lines. The direction of your trade (being long or short) should be directly related to the underlying trend identified by the linear regression line. Trading against the trend is considered a higher risk trade as there is no expectation that the price correction will revert to the opposite channel. As identified on the chart above it is not uncommon for stocks to move sideways or run along the channel line in a well-defined trend.

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