Understanding Trendlines
Trendlines are classically defined as manually drawn support or resistance lines. In 1948, Edwards and Magee established rules for applying trendlines in their book Technical Analysis of Stock Trends. Classic trendlines are subjective, relying heavily on the chart analyst's skill. While some analysts insist on unbroken lines, others argue that minor outliers can be ignored. Hand-drawing trendlines is repetitive and labor-intensive.
However, linear regression trendlines have gained popularity due to two key advantages:
- They are scientific and objective.
- Software automates their creation, enabling quick adjustments.
Defining Linear Regression
Like _standard deviation_, you don’t need to calculate linear regression manually—software handles it.
Linear regression minimizes the total distance between itself and every data point in a selected chart area. Below, a blue regression line and a red manual support line are compared. The red line connects lows, marking potential downward boundaries, while the blue line passes through the center of candlesticks.
Key Insight:
When manual lines parallel or overlap with regression lines, they validate the trend’s accuracy.
Practical Uses in Forex
Forex assumes a degree of central tendency—extreme price deviations often revert toward a trend’s center (e.g., linear regression or moving averages). By extending regression lines, traders project hypothetical price centers for future oscillations.
Example:
EUR/USD’s past regression lines sometimes predict future volatility patterns, though this isn’t guaranteed.
Limitation:
Linear regression rarely dictates buy/sell decisions directly but underpins indicators like channels (covered in advanced lessons).
Guidelines for Evaluating Trendlines
- Classic Support/Resistance: More "near-hits" strengthen validity.
Avoid lines where:
- Early points cluster too tightly (uncertain long-term reliability).
- Gaps between points are too wide (questionable relevance).
- Example: A support line tested 3 times initially but ignored for 30 periods likely needs redrawing.
Pro Tip: Chart Scaling
- Arithmetic Scale: Fixed price increments (e.g., +50 pips = same visual distance for GBP/USD and AUD/USD).
- Semi-Log Scale: Percentage-based increments, useful for long-term charts with extreme price swings. Most forex traders prefer arithmetic due to shorter timeframes.
FAQ
1. Why use linear regression over classic trendlines?
Regression eliminates subjectivity and is software-friendly, saving time.
2. Can regression lines predict forex prices?
They suggest possible reversion points but aren’t standalone signals.
3. How often should I redraw manual trendlines?
When price deviates significantly or breaks formation logic.
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Expanded with technical nuances and case studies to meet depth requirements.