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Expert Donchian Channel Strategy For Positive Gains

Donchian channel is a breakout trading indicator named after Richard Donchian , who was a pioneer in breakout trading methods and trend following.

The basic idea behind the Donchian channel is to buy when prices move above the highest price level of proceeding n number of days.


Table of Contents


Donchian system trading is a type of mechanical trading setup that involves following a set of predefined rules to enter and exit trades – a trading style popularized by legendary traders Richard Denis and Eckhardt.

Donchian channel

Formula for Donchian Channel

Upper Channel =N period Highest High

Middle Line=(Upper Channel + Lower Channel)/2

Lower Channel=N period lowest low

N period refers to time frame of consideration it can be minutes, hours, days,  week or months

Donchian channel Breakout System

Mr. Richard Donchain was among the first trend traders of financial markets, in his own words about trend following –

“From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases. Limit losses and ride profits, irrespective of all other rules. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting, and concentration on these moves will prevent unprofitable whip-sawing.”

-Richard Donchian

The Donchian channel breakout system generates a buy signal when the weekly closing price exceeds the highest price in the previous four weeks. A sell signal is generated when the weekly closing price falls below the lowest price in the previous four weeks.

Some traders nowadays use a 52 days period breakout which is also a very good time setting for donchian channel breakout strategy especially if traded over stocks only.

The turtles from the famous turtle experiment used this type of breakout system extensively. For this system, they used two types of exits. The first was a stop loss exit that was a maximum of 2N, or two average true ranges away from the entry point.

Second type of exit was based on risk management – Because the number of contracts to trade per market was also based on N (Average True Range), the maximum stop loss was 2% of account size.

Donchian Channel Trend Following System©

Donchian channel trend following system is a copyright system of bulls arena trading, It uses donchian channels for breakout and supertrend indicator for trend following. It is a comprehensive trend trading setup that has been backtested over 3 and 5 years and is commercially available.

Complete system is not available for generic use however we will  describe the foundation and technical introduction of donchian trend following system here –

Donchian channel trend following strategy

System Setup

  1. Plot DC for setting of 52 period
  2. Use Supertrend to ATR length of 20, factor of 2
  3. Use 200 day simple moving average

Long Entry

  • Initiate long position if prices cross median of donchian channel and supertrend gives long signal too, confirm prices above 200 moving average.

Short Entry

  • Short entry is placed only when prices are below 200 day simple moving average entry triggers once prices cross donchian median line from above and supertrend gives short signal.

Cover Long

  • If Supertrend changes its colour from green to red.

Cover Short

  • If supertrend changes colour from red to green.

Plotting Donchian Channel in Python

Below code represents a DC for  “ticker”  plotted in python –

import pandas as pd

import numpy as np

import matplotlib.pyplot as plt

def calcDonchianChannels(data: pd.DataFrame, period: int):

  data[“upperDon”] = data[“High”].rolling(period).max()

  data[“lowerDon”] = data[“Low”].rolling(period).min()

  data[“midDon”] = (data[“upperDon”] + data[“lowerDon”]) / 2

  return data

// To Plot a colourful donchian channel //

colors = plt.rcParams[“axes.prop_cycle”].by_key()[“color”]

plt.figure(figsize=(12, 8))

plt.plot(data[“Close”], label=”Close”)

plt.plot(data[“upperDon”], label=”Upper”, c=colors[1])

plt.plot(data[“lowerDon”], label=”Lower”, c=colors[4])

plt.plot(data[“midDon”], label=”Mid”, c=colors[2], linestyle=”:”)

plt.fill_between(data.index, data[“upperDon”], data[“lowerDon”], alpha=0.3,

                 color=colors[1])

plt.xlabel(“Date”)

plt.ylabel(“Price ($)”)

plt.title(f”Donchian Channels for {ticker}”)

plt.xticks(rotation=45)

plt.legend()

plt.show()

Bollinger Bands Vs Donchian Channels

Bollinger BandsDonchian Channels
Bollinger bands are based on volatility consideration of price movementAre based on price level breakouts from a predetermined periods
Bollinger bands use standard deviations to form upper and lower band Upper and lower bands are formed by breakout from highest high and lowest low of previous n period
Bollinger bands predict trend reversal and trend continuations with help of band squeeze and expansionThey indicate the potential start of an uptrend or downtrend.

Conclusion

There are other bands and envelopes used by traders in stock markets, but what distinguishes Donchian channels from other indicators is that it is purely based on price and responds directly to price movement. Another thing I like about this indicator is that it represents the basic philosophy behind trend following – “buy the strength and sell the weakness.”

To use DC with other price action trading methods, traders must work their way of getting a sweet spot for the lookback period , since it is an important consideration it should be well adjusted with timeframe of trading.

Here’s a quick reference to the lookback period and ATR adjusted to the trading timeframe –

Type Of TradingTimeframeLookback Period (N)ATR
Long TermWeekly2002
PositionalDaily522
Intraday1 hour / 15 min121
Scalping5 min or less11

Frequently Asked Questions

  1. What is the use of Donchian Channels?

    Donchian Channels are used for breakout trading strategies, they provide valuable information about price move in Price action trading.

  2. How is Donchian Channel calculated?

    They are calculated based on highest high and lowest low of lookback period n

  3. Is Donchian Channel a good indicator?

    There is no good or bad in trading world, every indicator used has its own drawbacks, if you are a price action trader you can utilize DC in your trading analysis but depending upon a single indicator to trade is a serious mistake.

Author

  • RUPIN JOSHI

    Rupin Joshi Senior Technical Analyst, Finance Writer, and Trading ExpertRupin Joshi is a seasoned Trading Expert with over a decade of experience. As a prolific Finance Writer, he has authored numerous research papers in Technical Analysis and Price Action. Rupin's insights and strategies have earned him global recognition, including awards in Trading Competitions. Currently serving as the Director at Bulls Arena Trading, he continues to empower traders and investors with his expertise and innovative approaches.

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