Linear Regression Divergence
Trade-Ideas uses the linear regression divergence formula to compare a stock’s price movement to a straight line. This formula is based on the way that many trading applications display the linear regression and the standard deviation on the same chart.
If a stock price moves in a perfectly straight line, that stock has a linear regression divergence of 0. This is sometimes called a “bunny.”
As the stock moves further from the mean, and closer to the lines drawn one standard deviation above and below the mean, the linear regression divergence approaches 1. If the stock price is usually about half way between the mean and one of the standard deviation lines, the value would be 0.5 for this stock.
Mathematicians often use the R-Squared value to say how much a chart looks like a straight line. Traders prefer to use the standard deviation because it is easy to show on a stock chart. Our formula uses the standard deviation so our results will match what traders typically see.
The linear regression divergence will give a low value for stock prices which look very linear on a stock chart. Like a typical stock chart, this formula sees how far the actual prices are from an ideal straight line. These errors are compared to the overall motion of the stock price to decide how significant they are. The idea is that if a stock price is going up very quickly, more noise is acceptable.
Trade-Ideas computes the linear regression divergence for each stock every night based on intraday charts for the previous 8 trading days. This value is available in our our free stock screener, and in our real-time product.