Stocks & Commodities V. 25:13 (72-78): Confirming Price Trend by Barbara Star, PhD

Confirming Price Trend by Barbara Star, PhD

Regression And R-Squared, Together Again Confirming Price Trend

Here’s a technique using linear regression slope and r-squared to confirm the price trend.

Linear regression is a statistical method some traders use to filter the static, or “noise,” created by day-to-day or bar-to-bar price movements. Using the least-squares method, it minimizes the amount of deviation among price values to determine a best-fit line. In an earlier STOCKS & COMMODITIES article, I showed that applying a linear regression indicator to price creates less lag and more trading opportunities than a moving average of the same length.

As useful as the linear regression indicator is for detecting price shifts, two other outputs derived from a linear regression may hold equal value for traders. In this article I will introduce two lesser-known indicators, r-squared and linear regression slope, which can serve as useful adjuncts when determining price trend and price direction.

R-SQUARED

R-squared is a measure of association. It measures the proportion of explained variation between the linear regression and the underlying data it is tracking. For traders that means the r-squared calculation identifies how closely the linear regression indicator matches the underlying price movement; the higher the r-squared value, the greater the correlation with the trending component of price. The eSignal code can be found in sidebar 1, “eSignal code for r-squared.”