The Donchian Channel is a trading indicator that allows you to visualize price ranges directly on your charts. The Donchian Channel has gained popularity after it was known that the famous Turtle Trader group was using the concept of trend-following breakout trading for their simple, yet effective trading method.
An introduction to the Donchian Channel
The reason why the Donchian Channel has been so popular is because it takes a natural market behavior and makes it easily accessible on the charts of traders. Typically, the Donchian Channels are applied to the daily charts with a 20 period setting. The bands of the Donchian Channel then visualize the absolute highs and lows of the past month.
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Traders pay a lot of attention to price ranges and monthly highs and lows. The concept of breakout and trend-following trading is very popular and once a market top – or monthly top – is broken, you can often see accelerating momentum when traders act on the same signal.
Donchian Channel for intra-day trading
Using the Donchian Channel on the lower timeframes is often not as reliable if the period setting hasn’t been adjusted. To trade intra-day breakouts, a trader would go to the 4H/1H charts and adjust the settings so that the channel encapsulates the weekly range.
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Traders who trade even lower timeframes can go on the 30min/15 min timeframe and adjust the settings so that the Channel visualizes the daily range.
The correct setting for the Donchian Channel is a key component to finding high probability setups. Applying the standard 20 period settings across different timeframes plots channels on your charts that do not provide meaningful information.
The Donchian Channel signals
The general signal occurs when price hits the upper or lower Donchian Channel. Trend-following traders would enter a long trade when the upper Channel is hit and a short trade on a touch of the lower Channel.
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The Donchian Channel indicator is a re-printing indicator which means that the Channel will re-print if price hits the outer bands and then keeps going. It is, therefore, advisable to use price alerts around the outer bands in order get accurate and timely signals.
Increasing signal accuracy
Traders who use the Donchian Channel for a trend-following approach should consider adding another indicator, preferably a momentum indicator such as the STOCHASTIC, the RSI or the MACD, in order to filter out low probability breakouts.
A Donchian Channel breakout that happens during a low momentum period is more likely to fail and result in a fake breakout. Furthermore, looking for other support and resistance levels is highly recommended; sometimes you get a Donchian signal just ahead of a support/resistance level and waiting for a confirmed breakout, instead of blindly acting on the Donchian Channel, can increase the winrate.
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On the other hand, a trader who trades fake breakouts can use the information of a failed Donchian Channel breakout and create reliable signals if he takes the reversal trades during low momentum price moves around support and resistance levels.
Donchian Channel as a stop loss tool
Although it would make sense to use the Donchian channel as a stop loss tool – placing your stop outside the opposite channel – such an approach results in large and often unreasonable stop losses. A trend-following trader who is long after a breakout of the upper Channel would set his stop loss below the low of the price range; however, his long trade idea would have been proven wrong much earlier.
Adding a moving average to the Donchian channel is the better alternative. If you see price breaking below its moving average after a rally, it is an earlier and equally reliable signal that the long position is no longer valid.
The Donchian Channel: good, but not as a standalone tool
The Donchian Channel is certainly one of the better indicators. However, traders who use the Donchian Channel to make trades have to consider the right period setting based on their timeframe and it is recommended to combine the Donchian Channel with other confirmation tools to increase the accuracy of trading signals.
There is a risk of loss in futures trading. Past performance is not indicative of future results.
