The Donchian Channel indicator was developed by Richard Donchian and is used in trading various markets including the forex market. The Donchian Channel is formed by taking the highest high and the lowest low of the last “x” amount of periods. The area between the high and the low is the channel for the users chosen periods. This technical indicator is not commonly available on most trading platforms although it can be downloaded for free and added to your platforms trading tools. The Donchian Channel can be used for trend trading and reversal trading on any trading instrument of your choice.
What is the Donchian Channel indicator?
Richard Donchian was born in 1905 in the city of Hartford (Connecticut, USA). At the beginning of his career, he was engaged in a family business selling oriental carpets. Still, then, after reading the book by Edwin Lefebvre, “Memoirs of a Stock Market Speaker,” he became seriously interested in stock trading.
In the process of working as an exchange analyst, Donchian developed a whole set of trading rules based on following the trend (for which he was later called the father of trading “by following the trend”). Based on these rules, a vast number of exchange trading systems were created, some of which are still relevant today.
Donchian Channel in MetaTrader 4 (MT4)
To build the Donchian channel in the MT4 trading terminal, first you need to download the indicator which you can find online by doing a quick search for Donchian Channel MT4. Once downloaded, you need to go to the menu items “Insert” – “Indicators” – “Custom” – “Donchian.”
Next, the indicator settings window appears. All channel settings are in the “Inputs” tab. You can adjust the periods depending on your individual trading style. The indicator can be used for forex scalping, day trading and swing trading.
How to use the Donchian Channel indicator?
The Donchian channel is built based on the absolute minimum and absolute maximum price for the selected period in its settings. The upper boundary of the channel is drawn through the highest price of the specified period, and the lower boundary is through the lowest price corresponding to the same period.
The period is set in terms of the number of candles; therefore, the period of 20 for the daily chart is 20 days, for the hourly chart – 20 hours, and for five minutes – 100 minutes.
Thus, a breakdown of a channel with a period of 20 on the daily chart will mean a breakdown of a twenty-day maximum (if the upper boundary of the channel is broken) or a breakdown of a twenty-day minimum (in case of breaking through the lower boundary).
It is no coincidence that we have repeatedly mentioned the value of the channel period equal to 20. The fact is that Richard Donchian himself recommended that this value be used. However, it should be understood that it was applied exclusively to daily charts (with a period of one day – D1) and meant nothing more than the average number of working days in a month.
The figure 20 is not some kind of dogma; on the contrary, each trader should experiment and choose the optimal value for the channel period based on which financial instrument and on the chart with which timeframe it is trading. I personally prefer to trade using the default indicator settings on the 1-hour charts and above. I tend to find that these charts contain less market noise than the lower timeframes and thus give more reliable signals for my forex trading strategies. This also means that I spend less time staring at charts and can also set alert notifications to let me know when price has reached certain levels or a particular indicator value has been reached.
As you have probably already noticed, the Donchian Channel we are considering is a classic indicator of volatility. With increasing volatility, the channel expands, and when it decreases, it narrows. In fact, the distance between the boundaries of the channel in points can be considered the current value of volatility.
The narrowing of the channel can be considered as a ranging signal, foreshadowing a rapid increase in volatility. This usually happens before a new trend begins or before the trend continues after a long period of price (flat) consolidation.
The price that reached it and forms some kind of reversal pattern is likely to unfold when it reaches the border, and the price that breaks the middle line (closed behind it) will most likely reach the opposite border of the channel.
Donchian Channel trading strategy
Common ways to trade with the Donchian Channel are to either take reversal trades or breakouts when price reaches the channel extremes. These extremes can also be used for placing stop loss and take profit levels although I would consider recent highs and lows as other areas for money management.
A sell signal arrives when the next candle closes below its lower border.
At the same time, traders may consider closing all short positions at the moment a buy signal arrives and all long ones at the moment a sell signal arrives.
Donchian Channel conclusion
The Donchian Channel indicator is flexible to differing market conditions, thus can be used as part of a forex trend trading strategy and forex range trading strategy. However, like any other technical analysis indicator, the Donchian Channel can give false signals, and several other market analysis tools can be used to filter them. In particular, traders may filter signals using the indicators Average Directional Movement Index (ADX) and Average True Range (ATR).
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