The Donchian breakout strategy looks for breakouts at the upper and lower channels. In this guide, we’ll talk about what the Donchian Channels are and what is the Donchian breakout strategy.
What are Donchian Channels?
Developed by Richard Donchian, the Donchian indicator uses moving averages to plot three channels or bands on the chart. They are the upper channel, lower channel, and middle channel.
The indicator follows the price action and draws these channels to help identify the direction of a trend. It can also help in determining the overbought and oversold levels.
If you are familiar with the Bollinger Bands, you can recognize Donchian Channels, as both indicators look identical.
Donchain Channels Breakout Strategy
The Donchian breakout strategy is easy-to-understand, as you look for the price breakout at the upper and lower channels. You can enter or exit the trades when the price touches the upper and lower channels.
When the price touches the upper channel, it suggests it has touched its high, and we can expect a downward move.
Conversely, when the price touches the lower channel, it has reached its lows, and we can see a potential upward move. The upper and lower channels can also be considered support and resistance levels.
Some people get confused with the middle channel when trading the Donchain breakout strategy, and they enter or exit the trades at the middle channel. However, the middle channel acts as a neutral channel, and you can’t consider it as a breakout strategy.
It is important to note that Donchian Channels are a lagging indicator, meaning they follow the trend rather than predict it. As such, they are best used in conjunction with other technical analysis tools to confirm potential trades.
The Donchain breakout strategy works on all timeframes; however, the higher the timeframe, the fewer false signals.
Buy Signal
- The price must touch the lower channel.
- Wait for the price to go upwards, and then enter the trade.
- You could place a stop-loss at the lower channel.
- You could set take-profit at the recent high or exit the trade when the price touches the upper channel.
Sell Signal
- The price must touch the upper channel.
- Wait for the price to go downwards, and then enter the trade.
- You could place a stop-loss at the upper channel.
- You could set take-profit at the recent low or exit the trade when the price touches the lower channel.
Donchain Breakout strategy Pros & Cons
The Donchian breakout strategy is simple to grasp, but you can’t rely fully on it. Here are the pros and cons.
Pros
- The Donchian breakout strategy is helpful for beginners.
- It can present clear entry and exit points.
Cons
- The breakout may not happen after reaching the upper and lower channels.
- The indicator can give false signals.
Conclusion
The Donchian breakout strategy looks for price breaks at the upper and lower channels. You can enter or exit the trades when the price touches these channels. You can add another indicator, like the RSI and MACD, to confirm the breakout. As with any forex strategy, you should have excellent money management so that one bad trade does not cancel out a consecutive run of winners. You can always practice trading on a forex demo account to begin with to improve your trading skills and build up your confidence.
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