- It is a technical indicator used to analyse the stock market.
- Linear regression is a technique used to analyse the relationship between two separate variables -price and time.
- The data is plotted along a normal distribution – bell curve and using this graph, traders can identify the prices at which the stock is overbought or oversold.
- Traders can also identify the entry price, stop loss price and the exit price.
This is a standard bell curve, 0 represents the mean position, +1 and -1 represent 1st standard deviation from mean.
+2 and -2 represent 2nd standard deviation from mean level.
This is the 1 day chart of Reliance Industries Ltd around Jan-Aug, 2020
Median line – orange, Top and bottom line – violet
- First, traders should mark the median line by taking the average prices in the trend.
- The first deviation in a bell curve is 34% away from the mean position on either side.
- Similarly, mark the lines in the chart. Also mark the second second deviation lines too.
- Mark the lower lines as -1 and -2, mean level as 0 and the upper lines as 1 and 2.
- The above chart indicates that the price is trading well within the first deviation from the mean price level.
- Traders can enter the trade and initiate their long positions when the price touches -2 and reverts back to -1.
- Their target price would be at the mean price level. If the price continues to rise further, the target price may be shifted to the line 1.
- Also the stop loss would be the -2 line which represents the second standard deviation.
- Similarly, traders can go short in the rally when the price touches 2 and reverts back to 1. Continue the trade if the price falls further.
- In this case, the exit price would be the -1 level. They can place a stop loss at the second standard deviation on the upper side.