Donchian Channel Strategy Explained What You Didn't Know About This Strategy

So what exactly is the Donchian Channel strategy? Well, the channel itself is effectively another indicator that traders can use to track the price movement of a given asset. The strategy involves using said channel to inform your entry points into the market and whether or not you issue buy or sell orders.

The Donchian Channel gets its name from its inventor, Richard Donchian, who has been dubbed the “Godfather of Trend Trading”. Donchian himself was a futures trader in the mid 20th century and sought a way of trying to make sense of volatility. The original premise was intended for use on daily values, but today it is adapted and applied to just about any timeframe.

What does it mean for traders?

In essence, it is very similar to many other chart bands and involves three lines – the upper, the lower and the median. The upper line shows the highest price an asset or security has reached in the selected time frame, whilst the lower line indicates the lowest price. The line in the middle is used to indicate the average between the two.

With CAPEX, you get to learn and practice different strategies without risk, using the demo account provided with all accounts.

At first glance, the Donchian channel strategy bears striking resemblance to the Bollinger Band strategy, but it has many of its own advantages and, in actual fact, the two strategies can be used to complement one another.

Pros of the Donchian Channel strategy:

• A useful way to visualise market volatility
• Can be applied to numerous markets
• Highly adaptable
• Can be used in conjunction with other strategies

Cons of the Donchian Channel strategy:

• Susceptible to false breakout signals

Ultimately, the pros and cons of the Donchian Channel strategy will vary depending on your individual approach to trading. The Donchian channel strategy is relatively easy to get to grips with. However, on the other hand, it is often better used with other strategies, which is where things get a little more complex. If you want to keep improving your skills as a trader, don’t skip the CAPEX Academy, where you’ll become a better trader in no time.

As we’ve noted, the Donchian Channel lines are a way of visualising market volatility and the associated strategy involves using certain markers to inform your trades. To start using the Donchian Channel strategy on the financial markets, you’ll need to take the following steps:

1. Open a trading account: First thing’s first, if you want to start using trading strategies then you’ll need a trading account. You can refer to our guide on finding the best online broker, which will give you an idea of the features to look out for, all of them you’ll find at CAPEX.
2. Learn to read charts: There’s no getting around it; if you want to be successful as a trader then you need to learn how to read charts like the ones you’ll find on our platforms. Strategies like Donchian Channel are actually based around the charts, so it is especially important that you have a firm understanding of what all the numbers and patterns on screen actually mean.
3. Choose your market: One of the biggest advantages of the Donchian Channel strategy is that it can be applied to pretty much any market. At CAPEX, we offer trading in over 2100 different instruments and you can use the Donchian approach on just about all of them. If you are just discovering the strategy for the first time, it’s best to concentrate on two or three markets. You can stick with one, but it’s good to see the principles of the strategy at work on different asset classes.
4. Drawing the Donchian Channel lines: We’ve already touched upon what the three Donchian channel lines are based on: the upper line represents the asset’s highest price for the given time frame, the lower line represents the lowest price and the middle line is the average. Thankfully, adding these lines to your charts is easy as our trading platforms here at CAPEX have these tools built into their functions. Once the bands are in place, you can use them to identify trends within the asset’s price movement which then allows us to make informed predictions and find future opportunities.
5. When to enter and exit a trade: There are a few ways that you can use the Donchian Channel strategy to choose when to enter and exit into trades. A lot of traders use the middle line as the key indicator, with the general approach being to go long when prices move above the middle line and to go short when it drops below. These positions can then, in theory, remain open until prices hit the upper or lower lines, depending on the order type.

Many traders will hold the position if the price rises steeply above the upper line, as this could indicate a bull market. The reverse is of course true for sudden drops outside of the lower band. However, positions should only be held open if the asset is trading consistently outside of the channel.

Also, at CAPEX you’ll be able to set limit and stop-loss orders, which would help you manage your risk better.

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