Price movements are characterized by swings from one extreme to the other as the market reflects the collective mood of traders. As the market becomes overly optimistic, prices are driven up. When the mood of the market becomes overly pessimistic, prices are driven down.
Every issue tends to have an equilibrium point towards which prices seem to be drawn to. While Linear Regression analysis can be helpful in determining where this point will fall, Standard Error Channel analysis can show if prices are cycling higher or lower than equilibrium and if a change in trend may be about to occur.
Standard Error Channels are calculated by plotting two parallel lines above and below an x- period linear regression trend line. The lines are plotted a specified number of standard errors away from the linear regression trend line.
It is used to validate overbought/oversold signals. It is also useful to validate support/resistance. 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.