What are Donchian Channels and How Are They Used?
Donchian Channels act as an envelope encircling a set of data which are related to prices. This is a stirring indicator which is very average and invented by Mr. Richard Donchian. It marks the highest point and the lowest point over the last intervals of time periods. The peak is the highest high channel over a given period of time on the other hand the bottom part is the lowest low channel over the similar period of time. This follows a simple trending system. Similar to other channels, a stock may be traded inside the same limit of the same channel from one end to the other at the same time being aware for the possible breakouts in either direct or false breakouts.
One may derive signals using this system which methods are based on a certain set of rules. For example, if a price goes beyond the Donchian Channels, you may buy long and can cover short positions. On the other hand, if a price goes down below the said channel, you can have the option to sell short and may liquidate long positions. Be reminded that mathematically speaking, it is quite impossible for stocks to have breakouts in these channels due to channels such as these would immediately move away if a new tremendous price was strike given that the peak of the channel and the bottom of it are considered the highest high and lowest low of a specified time period.
The peak and the bottom of the Donchian Channels may be considered as a good foundation and defense points. Moreover, the mid line or middle point could be utilized as same as a moving average, if a price below the middle point which may point out a downtrend, while if a price is beyond the mid line which indicates an uptrend.
Always remember that using the parameter O/H/L/C/M as C or for close, then the channels have the tendency to use a higher close and lower close, if you decided to use H or L the channels might use the higher high and the lower low, Then if you try to use O the channels might use the higher open and lower open, while choosing to use M the channels can use higher mid point and the lower mid point (H+L+C)/3).
Being considered as one of the simplest system that follows a certain trend, this channel could recognize breakouts. Richard Donchian also gives further details about the system in a 1970 booklet, utilizing these channels to make use of his four week rule. He also theoretically conceptualized the Donchian channels through the top state line set at the peak high for the prior four weeks and the lower edge at the lowest low for that specific period. Although this system may not be as simple as it is, but it does not perplex simplicity in line of being not effective. Studies also had comparisons among various trading systems that consistently spot breakout systems as those that create the most advantage of gaining profits. This information could give you an idea to consider looking at Donchian channels.
Richard Donchian make it as possible to always stay in the present market, wrapping positions which are short and going into long ones if a time comes that prices exceeded the top channel, at the same time liquidate the positions which are long and going into short ones if a price decreases below the bottom channel. The default 20 setting on most of these channels reflects that four-week setting, with 20 days comprising 4 trading weeks.