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Donchian Channel

Posted in Indicators of technical analysis

Donchian Channel was created by Richard Donchian and published in 1970.

How to calculate the Donchian Channel:

 

Upper channel = HH np

Lower channel = LL np

Middle value = (upper channel + Lower channel) / 2

 

HH np = Highest High in time period used for calculation
LL np = Lowest Low in time period used for calculation

 

Usual setting of Donchian Channel is to 20 days, but it is also possible to set it anywhere within the range of one week to several months (intraday traders use much lower time periods, of couse).


Donchian channel construction is based on reached Highest High and Lowest Low within selected time period. E.g. if today the new Highest High was reached, tomorrow it becomes the new upper channel until any new Highest High would be achieved, or until the selected time period would not expire. Until the HH is not exceeded within the period, the upper channel remains unchanged and does not decrease neither in case the Uptrend turns to Downtrend. By analogy, the same is true for lower Donchian Channel.    

How to use the Donchian channel:

If the price closes above the upper Donchian channel, enter the Long trade. Should it close bellow the lower DC, enter the Short trade.

As you can see, the Donchian Channel does not identify the trend reversals. It just serves to define and make use of the prevailing trends. Despite the fact the DC tempts the traders to trade continuously, it is better to exit opened positions at Stop Loss level and don't wait until the price closes Above/Bellow the opposite channel.


Donchian channel gives a lot of false trading signals in the time of choppy market and it becomes very profitable during strong trending market. If the time period is set to a longer time, we catch the major trend reversals. If we set it to a shorter period, we catch the shorter trends mainly. Stop loss can be placed into the area of its middle value.


We can use the Donchian Channel to identify the Supports and Resistances, as well. It is better to combine it with other trend indicator to get better Entry and Exit points.

If you are interested in a deeper study of this technical indicator and prefer ready to serve solutions, this section may be of  interest to you. There you can find all the available indicators in Excel file for download.


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