Linear Regression Bands

BarroMetrics Views: Linear Regression Bands

Firstly, Ana, thank you for taking over the past two days; I really appreciate your efforts.

Secondly, my apologies to those whose e-mails I have yet to reply to; rest assured I shall be attending to replies and should answer all by the weekend.

I have received a ton of mail following this week’s video regarding the use of Linear Regression Bands.  I’ll answer the queries in this blog.

One of the patterns I use for changes in trend is the Higher Timeframe Line Turn (see Nature of Trends).  However there were times when a higher time frame line change did not visually signal a change in trend in  the Trader Timeframe.  For this reason, I brought in the Linear Regression Bands, 3 stdev rule.

The rule says that a change in trend in the Trader Timeframe is signaled when:

  1. The Higher Timeframe line turns and
  2. We see acceptance beyond the Linear Regression Band extremes.

Sometimes, the application of the two conditions results in a later signal; but I have found that the use of the Bands leads to more reliable indications of the change in trend.

2009-10-08-blog-co-18d-_1.jpg

FIGURE 1 Crude Oil

Figure 1 shows Crude Oil: after the reaction low on July 29 2008. We note that:

  • The line turn price for the 13-week (quarterly trend) is coming in at 119.82.
  • The 18-day swing low is 85.42. Normally without one of the Lagging Change in Trend Patterns (see Nature of Trends) we need to see a breach of 85.42 before we can say the 18-day uptrend has ended.
  • But with the Higher Timeframe Line Change Rule,  we’d say the 18-day trend is deemed to have changed when the 13-week line turns at 119.82.
  • The new rule would require acceptance below the bottom ( 3 stdev)  of the Linear Regression Band.

Figure 2 shows  the equivalent of the 13-week line turns on Aug 4. At this stage, under the new Rule, we have a warning of a possible change in trend in the 18-day.

2009-10-08-blog-co-18d-_2.jpg

FIGURE 2 Crude Oil

With that warning, I would place longs on hold. Generally, once the Higher Timeframe line turns, we’ll see prices reach the appropriate extreme of the Band (in this case, the bottom band).

2009-10-08-blog-co-18d-_3.jpg

FIGURE 3 Crude Oil

Figure 3 shows that Crude bounced off the bottom Band. Longs would have been placed either on Aug 20 or Aug 21 and exited on Aug 22. (last bar in Fig 3).

2009-10-08-blog-co-18d-_4.jpg

FIGURE 4 Crude Oil

On Sept 5, with acceptance below the bottom Band and the Maximum Extension, the trend would have been deemed down and I’d have instituted shorts.  Note that had the bar I have labeled ‘Neutral Bar’ in Figure 4 been a bearish conviction bar, I would have deemed the trend down on Sept 4.

I’ll conclude this tomorrow.

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