Today’s video is on the Donchian Channel indicator. Developed by Richard Donchian, this trend following indicator uses price channels that are determined by the highest high and lowest low of the previous period, normally 20 days. The Donchian Channel indicator can be used to help determine entry and exit points, visualize market volatility, and help identify breakouts and trend reversals.
The upper channel is drawn based on the highest price during the previous periods and the bottom channel is drawn based on the lowest price. The midline is the centerline between the upper and lower channels. Donchian Channels can be used on intraday, daily, weekly, and monthly charts and traders can adjust the period depending on their goals. Shorter periods will produce tighter channels, while longer periods will produce wider channels.
Volatility and Trend Identification
Donchian Channels can be useful in visualizing the volatility of a market’s price action. If the price is stable, the Donchian Channel will be relatively narrow. If the price has large fluctuations, the Donchian Channel will be wider.
Using the 20 day default period, a move above the channel signals a new 20 day high. Similarly, using a 20 week period, a move above the channel would signal a new 20 week high. Markets that continuously touch or exceed the upper channel line show strength, while conversely markets that continuously touch or break below the lower channel line show weakness.
Traders can also use the midline as a trend confirmation indicator. If the security remains above the midline, traders may remain in a trade long. If the security remains below the midline, traders may remain in the trade short. If the security crosses the midline, a change in trend is possible.
Entry and Exit Points
Donchian Channels are commonly used to help determine entry and exit signals using a simple breakout system. If the price closes above the channel, buy long and cover short positions. If the price closes below the channel, sell short and exit long positions. When the price breaks out above or below the channel, the channel can then serve as support and resistance areas.