Channel indicators have one serious drawback – they draw one channel. And when the price breaks through it, the question arises: is the breakout false? Or is it impulsive? Will the price return to the channel or will the channel redraw in the direction of the price movement? Logically, in any case, the price returns to the channel, but before that, it can hook your stop or lead to a substantial drawdown of the deposit, losing on nerves. But what if we draw several channels that will display the probability of a breakdown or a rebound? A similar idea is implemented at Pivot points, where there are three levels of resistance and support equidistant from the median. But they don’t have flexibility. The Mean Reversion channel indicator is a solution to this problem (Template here).
Mean Reversion indicator – settings and application example
Resistance and support levels are a good tool, but they have the problem of false breakouts. There are two ways to identify a true breakdown:
- The breakdown candle closes outside the level. The next candle continues towards the breakdown.
- After the breakout, the price returns to the level, but does not enter the channel, but bounces off the level towards the breakout.
The Mean Reversion indicator allows you to determine the truth of the breakdown with a high probability by filtering out false signals. It is installed in the standard way through the data directory in MT4. It is applied on any currency pairs and timeframes.
The indicator consists of 7 lines forming channels, which are calculated using the standard deviation from the median line. The central line is the median. The main zone is delimited by gray (default) lines. In the example below, these lines are changed to yellow.
Indicator settings:
- Enable/disable price labels on the chart.
- The number of candles involved in the calculation.
- Standard deviation coefficient. Narrows or widens channels. The parameter is selected individually for each asset and timeframe.
- The relative position of the gray lines (yellow in the example below). The value of the parameter is from 0 to 1.
Trade opening options:
- The outer lines of the channel are overbought and oversold zones, the touch of which means the exhaustion of the forces of buyers or sellers. Accordingly, the transaction opens at the time of the rebound from them. The preliminary settings of the indicator are adjusted to the level of price volatility so that it stays inside the channel all the time. The bounce point should coincide with the horizontal resistance/support level.
- The indicator is set so that the price is between the gray (yellow in the example below) lines. The extreme lines are used to set stops, the inner red lines are used to set the first profit target, where 50% of the transaction is closed and a trailing stop is set. Trades are also opened in the direction of the channel. If the price goes down, the channel is directed up, the signal is ignored.
Example. The idea of this strategy is based on the fact that the extreme boundaries serve as a guideline for building a channel. The yellow lines serve as the trade opening level, the opposite red lines serve as the target level.
- 1 – Points of construction of extreme blue levels.
- 2 – The point of opening a short position. Blue levels are the strongest levels that the price rarely reaches. Therefore, we are waiting for the breakdown of the yellow levels, and after the price returns to the channel, we open a position.
- 3 – The middle of the channel. We close 50% of the position, set a trailing stop for the H4 timeframe at a distance of 15-20 points.
- 4 – Take profit.
Output. Mean Reversion is a flexible channel indicator that allows you to adapt to different types of strategies. By managing the settings, you build any channels, the lines of which will serve as signals, safety levels or closing points of transactions. Although it does not have clear options for interpreting signals, with a good setting it is able to give rare but accurate ideas for opening a trade.
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