The Donchian channel indicator, also known as Price Channel, was developed in the beginning of the 1970s by Richard Donchian. He is famous for his technical analysis of financial markets. Price Channel belongs to trend following indicators and is similar to well known Bollinger Bands indicator by its signals and layout. However, unlike Bollinger Bands, Donchain's price channels are based on high and low prices over a certain period of time.
DonchianChannel Upper = HH(n), the Highest High for n periods
DonchianChannel Lower = LL(n), the Lowest Low for n periods
DonchianChannel Middle = (DonchianChannel Upper + DonchianChannel Lower) / 2
Price Channel can work well for technical basis, trend and countertrend trading systems.
The classic rules of the trading system based on this indicator presuppose:
- Asset purchase when the price is closed over the channel of 20
- Asset sale when the price is fixed below the channel of 20
- Closing of short positions when the channel is formed over the 5 period
- Closing of long positions when the channel is formed below 5 period
To simplify the search of breakout signals, it is necessary to use bias indicator with the dimension of +2.
Such trading style can be applied to intraday, mid-term, and long-term operations on both commodity and financial trend markets.
As the international exchange market is mainly of sideways or flat nature, it is required to use trade filters if you want to get the best of the breakout system based on Price Channel indicator. Thus, the signals forming the price outside of the Donchian channel will be selected.
It is much better to combine these breakout signals and filter them through ADX (the trend strength indicator) and ATR (measures the volatility of price changes) indicators.
Exits based on Price Channel indicator enable to close trades without losses during correctional retracement which usually takes place after powerful price breakthrough. Such situation usually occurs when the price moves significantly away from the channel after breaking its boundaries which does not allow losing funds when moving back and contribute to the most profitable close of the deal.
InstaForex Donchian Channel Parameters
period - 20
displacement - 2
mode - 1 or 2
When mode = 1, indicator is based on Highest High and Lowest Low of the last n periods
When mode = 2, indicator is based on Close of the last n periods