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Standard
Error Channel
Description
Standard
Error Channels are calculated by plotting two
parallel lines above and below an x-period linear
regression trendline.
The lines are plotted a specified number of
standard errors away from the linear regression
trendline.
For
information on other channel-based line studies,
see Envelopes,,
Raff Regression Channels, Standard
Deviation Channels, and Standard
Error Bands.
Interpretation
Price
movements are characterized by swings from one
extreme to the other.
Markets reflect the collective mood if its
participants. When
market participants are overly optimistic, prices
are driven up at an unsustainable rate.
Likewise, when market participants are
overly pessimistic, prices are beaten down at an
unsustainable rate.
The keywords here are "extreme"
and "unsustainable."
Even the most raging bull markets or
violent bear markets will either pause for a
breather or reverse temporarily.
Markets
tend to have an equilibrium point (i.e., a point
towards which prices tend to be drawn).
Linear regression analysis is helpful in
determining where this "balancing point"
lies. On
the other hand, standard error analysis is helpful
in determining where the "extremes" lie.
Standard
Error Channels can be used to enhance several
types of technical analysis techniques.
Here are some ideas:
-
Validate
candlestick patterns:
Enter long on bullish engulfing lines
only if they have formed below the bottom
channel line.
-
Validate
overbought/oversold signals:
Close long (or enter short) when the
Stochastic falls below 80, volume is above
average, and prices have recently fallen below
the top channel line.
- Validate
support/resistance breakouts:
If prices have broken above a long-term
resistance level, yet volume is suspiciously
light, wait until the prices break above the
upper channel on above average volume.
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