The PRC (Polynomial Regression Channel) is a regression indicator that draws a line to fit best on the chart. It applies a polynomial function to linear regression function (three-line technical indicator used for analyzing upper and lower band limits of the trend) through recent period’s data. That’s why it is also called the Linear Regression Channel. As the Polynomial Regression Channel is a regression band, it adjusts itself for volatility.
What is the Polynomial Regression Channel?
The word PRC stands for Polynomial Regression Channel. This is a regression indicator that is used on charts. A linear regression indicator draws a straight line of best fit on a chart. The PRC indicator applies the polynomial function to the linear regression functions to adapt itself to market flow.
The Polynomial Regression Channel uses bands to identity trends on the chart. It uses a polynomial degree (1-6) and a number of bars to analyze data.
Bands are present above and below the regression line between multiples of standard deviation. The regression line must form a parabola. If it forms a straight line, the Polynomial Regression Channel won’t work.
The polynomial regression is a term in statistics representing the relationship between the independent variable x and the dependent variable y. It creates a polynomial function on the chart to display the set of data points.
The basic polynomial function is represented as f (x) = c0 + c1 x + c2 x2 ⋯ cn xn
Where n is the degree of a polynomial, and c is a set of coefficients.
The Polynomial Regression Channel uses n=1 to show a set of data points with the low error value. But a linear regression line can’t appear with the low error value.
So, the Polynomial Regression Channel uses the value of n is 2 or 3 to form the parabola. When these values are entered, a trader can create trading zones.
How to use the Polynomial Regression Channel?
A common indicator that is used by many trading platforms is called the linear or polynomial regression channel, this creates boundaries around the price action where the price found support and resistance from the bulls and the bears, the image below shows this in action. You can see the PRC formula has 5 lines, at the top and the bottom, you have the outer and inner band of the channel and in the centre, you have the middle band which is deemed as neutral.
As we mentioned, the Polynomial Regression Channel uses a degree of polynomial to display data points. This creates boundaries around the price. Here the support and resistance come into play from the bears and the bulls.
The bullish trend appears when the price is increasing, and the slope of the regression line is positive. This is known as a bullish regression channel.
The bearish trend appears when there is a decrease in price, and the slope of the regression line is negative. This is known as the bearish regression channel.
With the Polynomial Regression Channel, you have the upper band, the lower band, and the neutral band. The neutral band is present in the middle.
To trade on the Polynomial Regression Channel, we need to keep an eye when the price interacts with one of these bands.
Each time the price hits the upper band or the lower band, this can be a signal to buy or sell. The bands adjust themselves depending on the uptrend and the downtrend.
You can choose your own settings for the indicator or author’s settings.
Polynomial Regression Channel Strategy
Trading the Linear Regression Channel involves keeping an eye on the price whenever it interacts with one of the three lines. Each time that the price interacts with the Upper or Lower Channel, you should expect to see a potential turning point on the price chart.
The basic strategy for Polynomial Regression Channel is to buy when the price is in the lower band and sell when the price is in the upper band. The trader may choose to exit when the price is in the middle band.
By using Polynomial Regression Channel in a trading strategy, traders can try to detect the trend’s direction. For example, when the price hits the upper band, this sometimes indicates the market is in a downtrend.
Polynomial Regression Channel buy strategy
- The price should enter the lower band region.
- Wait for the price to close bullish before entering.
- Place the stop-loss near the swing low area.
- Exit the trade when CCI is above 50.
Polynomial Regression Channel sell strategy
- The price should enter the upper band region.
- Wait for the price to close bullish before entry.
- Place the stop-loss near the swing low area.
- Exit the trade when CCI is below 50.
Polynomial Regression Channel Conclusion
Polynomial regression is useful in many cases. Since a relationship between the independent and dependent variables isn’t required to be linear, you get more freedom in the choice of datasets and situations you can be working with. So this method can be applied when simple linear regression underfits the data.
Polynomial Regression Channel can be a useful trading tool for identifying a major trend in the market. You can apply it on any timeframe, and it will calculate on your defined timeframe.
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