Raff Regression Channel For Trend Confirmation

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Raff Regression Channel For Trend Confirmation

The Raff Regression channel, created by Gilbert Raff, is not a popular indicator. Chances are you have never heard of it. The reason for that may be because it doesn’t provide any trade signals, which many traders want. The Raff regression channel is a great confirmation tool though, both for seeing active trends and helping to spot trend reversals.

For simplicity, and without going into any math, think of a “regression line” as a line of best fit. When you connect a regression line to the low and high point of a trend, the regression line will swivel all over the place as it calculates the ideal trajectory. The end result is a line that runs through most of the price action (it looks very different than how you would draw a trendline).

A Raff channel is created by running parallel lines along the same trajectory as the regression line.

Figure 1 shows a Raff regression channel applied to the long-term uptrend in S&P 500 ETF (SPY).

S&P ETF Weekly Chart with Raff Regression Channel

The middle white line is the regression line–the line which tries to “best fit” the trend. Notice how the line doesn’t actually touch the high and low points of the trend. When you start the line at the low (just after 09) and extend it to touch the high point, it will re-adjust itself to fit all the data you are covering.

The outer lines form the channel which contains the trend.

Effectively Using a Raff Regression Channel

The channel width is determined by the deepest pullback so far in the trend.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Because the channel distance is based off the largest pullback, it is recommend that a Raff regression channel is only applied to “mature” trends that have seen at least two good size pullbacks.

When looking at price action, velocity and magnitude of price moves are important. When a pullback occurs that is larger than the prior pullbacks (especially if we already have two substantial pullbacks in the trend), it is an indication that trend may be reversing (not always, but likely).

Figure 2. Raff Applied to First Wave of Major Trend (arrows mark the price points used to create the regression)

The regression does a good job of containing the initial wave of the trend. Short-term traders may wish to apply the channel to all waves of a trend so they can spot when a larger pullback is underway. Since this first wave didn’t contain large pullbacks (relatively speaking), the channel is broken on a large pullback.

To maintain a view of the overall trend, the Raff regression needs to be redrawn as each wave occurs. Once two major pullbacks are contained within the regression then it is quite likely that when it is broken again the overall trend may be reversing.

Figure 3 shows how the channel looks after two waves higher, but still only one big pullback. The arrows show the price points used to make the regression. It still does not encompass the next big pullback though.

Figure 3.

Figure 4 below shows what the channel looks like when both of the first two major pullbacks are included in the data.

Figure 4.

Now that the channel encompasses two broad pullbacks (there are two pullbacks that occur between the two arrow points I have used to create the channel) it does a much better job of encompassing the future trend.

The next time the price breaks below this regression channels means the price is already in a shorter-term downtrend and is showing significant weakness on this time frame.

Each trend will be a bit different. As a rule of thumb you want to include at least two substantial pullbacks to create an overall trend channel for the trend. Sometimes you’ll only need one pullback (if it ends up being larger than future pullbacks). Other times you may need to include 3 or 4 pullbacks if one of those ends up being larger than the prior pullbacks.

As indicated, this tool is best applied to a mature trend, such as the example shown in the chart–this trend has been effect for 5 years.

The time frame doesn’t matter. I have used a weekly chart, but this could just as easily be a 1-minute chart or a 5-minute chart. The same guidelines still apply. Long-term on a 1-minute may be a couple hours, for example.

As long as the price remains in the channel the trend can be considered up. If it breaks out it signals a reversal….BUT, if the price is still making higher highs and higher lows and the price keeps moving higher after a breakout, then simply redraw the regression channel to encompass the new data. The more data the channel encompasses the more accurate it becomes in spotting future reversals, and keeping you trading in the direction of the trend.

The same principles apply to downtrends.

Since this indicator is not a trading method, you’ll still need a strategy to actually create buy and sell signals.

Using the Raff Regression Channel to Identify Trend Reversals in FDN

Today’s article will show how the use the Raff Regression Channel to define the trend and identify reversals using the Internet ETF (FDN). I am particularly interested in FDN because internet stocks represent the appetite for risk. An uptrend in FDN signals a strong appetite for risk and this is positive for the technology sector. A downtrend in FDN signals a weak appetite for risk and this is negative for the technology sector.

The middle line of the Raff Regression Channel is a linear regression, which is the line of best fit for closing prices. The outer lines are set equidistant from the furthest high or low. The first step to using the Raff Regression Channel is to identify the beginning and ending of a move. An advance begins with the closing low and ends with the highest closing high. A subsequent higher closing price would warrant an upward extension of the channel. A decline begins with the closing high and extends to the lowest closing low. A subsequent lower closing price would warrant a downward extension of channel.

The chart above shows the Raff Regression Channel extending up from the May closing low to the September closing high, which was last week. Should the ETF close above this high in the coming weeks, I would extend the Raff Regression Channel further. I am most interested in the lower line because a close below this line would signal a trend reversal. The channel is rising for the moment and this means FDN is in an uptrend. Hence, the appetite for risk is strong and this is positive for the technology sector.

Good trading and good weekend!
Arthur Hill CMT

Raff Regression Channel

Table of Contents

Raff Regression Channel

Introduction

Developed by Gilbert Raff, the Raff Regression Channel is a linear regression with evenly spaced trend lines above and below. The width of the channel is based on the high or low that is the furthest from the linear regression. The trend is up as long as prices rise within this channel. An uptrend reverses when price breaks below the channel extension. The trend is down as long as prices decline within the channel. Similarly, a downtrend reverses when price breaks above the channel extension.

Formula

The Raff Regression Channel (RRC) is based on a linear regression, which is the least-squares line-of-best-fit for a price series. Even though the formula is beyond the scope of this article, linear regressions are easy to understand with a visual example. Chart 1 shows the Nasdaq 100 ETF (QQQQ) with the Raff Regression Channel in red. The middle line is the linear regression extending from the July closing low to the January closing high. Note that the linear regression is based on closing prices. This makes the linear regression the line-of-best-fit for the closing prices from the July low to the January high. Next, the width is set by determining the high or low that is the furthest from the linear regression (early July to mid-January). In this case, the next day’s low is the furthest and is used to set the lower channel trend line. The upper trend line is then set the same distance from the linear regression as the lower trend line.

Chart 2 shows an example of QQQQ in a downtrend. The Raff Regression Channel extends from the April (closing) high to the July (closing) low. The late June high defines the width of the channel because it is the furthest high or low from the linear regression. This means the lower trend line is set the same distance from the linear regression as the upper trend line.

Drawing and Signals

The Raff Regression Channel can be drawn to cover the existing trend and subsequently define the trend. Once established, extension lines can be drawn to identify the support, resistance or reversal points. An uptrend extends from the lowest closing low to the highest closing high for a move. A downtrend extends from the highest closing high to the lowest closing low. Keep in mind that closing prices are used when drawing the Raff Regression Channel, but intraday highs and lows are used to set the channel trend lines.

Chart 3 shows Urban Outfitters (URBN) with the Raff Regression Channel drawn from the July 2007 low to the September 2008 high (weekly closes). This covers the uptrend so far. Had URBN moved to a new closing high in October, the Raff Regression Channel would have extended to that high. Instead, URBN broke below the regression channel extension to reverse the uptrend. Notice that the lower trend line was extended to extrapolate the channel.

Chart 4 shows Nvidia (NVDA) with a downtrend extending from the October 2007 high to the November 2008 low. The Raff Regression Channel did not extend further because the stock traded flat and held above its November low into 2009. The red dotted line shows the channel extension of the regression channel top. NVDA broke this extension in February-March to start an uptrend.

Conclusion

As a channel based on a linear regression, the Raff Regression Channel is well suited for trend identification. The width of the channel depends on the furthest high or low from the linear regression. As such, spike highs and lows will result in very wide channels that may not capture the true range. When an uptrend starts with a sharp surge, the low that follows this initial surge is often the furthest high-low from the linear regression. By extension, when a downtrend starts with a sharp decline, the high of this initial decline is often the furthest high-low from the linear regression. Sharp initial moves create wide channels with few, if any, reaction highs or lows touching the upper and lower trend lines. Such was the case with the surge off of the March 2009 lows (see the QQQQ chart further below). Even though this article only focused on trend identification, the Raff Regression Channel can be drawn early in the trend and extended to forecast future support or resistance levels as well as overbought or oversold levels. Channel extensions can act as support or resistance. Moves outside the channel extensions can also denote overbought or oversold conditions.

Using with SharpCharts

You can use our ChartNotes annotation tool to add Raff Regression Channels to your charts. Below, you’ll find an example of a chart annotated with two Raff Regression Channel annotations.

To learn more about how to add this annotation to your charts, check out our Support Center article on ChartNotes’ Line Study Tools.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Broker!
    Perfect for beginners!
    Free Demo Account! Free Trading Education!

  • Binomo
    Binomo

    Only for experienced traders!

Like this post? Please share to your friends:
How To Choose Binary Options Broker
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: