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