Learn How to Trade with the Legendary Donchian Channel Indicator

donchian-channel-on-screen

Are you curious which Forex indicator is simple yet effective at the same time? I’m sure that all traders are looking for that special indicator taking care of all your trading decisions. Although this “Holy Grail” indicator does not exist, there is one particular tool that we find to be very beneficial for taking trading decisions: the Donchian channel indicator.

The Donchian is actually the heart of a legendary trading story called the “Turtle Traders”, where Richard Dennis proved his point that anyone could trade successfully if they receive the right support and tools. The system that Dennis taught to his traders was based on the Donchian indicator.

How does the Donchian Indicator Work

The Donchian channel simply adds two lines to the chart:

  1. One line is the highest high.
  2. One line is the lowest low.

The high and low are relative to time period used. If you choose a period of 10, then the Donchian channel will show the price of the highest high and the lowest low of those 10 candles (periods/bars. Traders can freely choose a time period of their choice, but the most used setting is 20 days.

What does the indicator really indicate?

When the indicator lines are flat, the price is not capable of confirming a new high or new low.

  • When the top indicator line has an angle, this means a new high has been made.
  • When the bottom line has an angle, it means a new low has been made.
Donchian Channel lines

Image: showing Donchian channel lines.

How can Traders use the Donchian Channel?

The Donchian candle basically offers support and resistance (S&R). There are numerous Forex indicators that show S&R but the Donchian is seen by many as one of the best.

Support and resistance levels work differently depending on whether a trend or range is present on the price chart:

  • During a range: price tends to respect S&R levels and not break them.
  • During a trend: price tends to break above or below S&R levels with the trend.

The Turtle Traders mentioned earlier used the Donchian channel for trend continuation trade setups. In general, traders can use Donchian for bounces and breakouts:

  • Uptrend: Donchian low is support and Donchian high is a breakout level.
  • Downtrend: Donchian high is resistance and Donchian low is a breakout level.

Which Time Frames are the Best for Donchian Channel?

Logically, lower time frames are showing a smaller part of the price action than higher time frames. Daily charts tend to offer more importance than 15-minute charts for most traders.

The reality, however, is that the market is fractal in nature and the price patterns repeat in similar ways on all levels. In our view, the Donchian Channel is a valid indicator and tool for (almost) all time frames. The most important question is really how to use it.

Using Donchian Channel in a Trading System

The Donchian Channel is a fine tool but the indicator becomes more valuable when it’s part of an overall strategy to tackle the markets.

A Forex trading system helps traders analyze the price chart and identify solid entry and exit points. A system also addresses how to spot the best setups and avoid trades with bad odds. It also outlines how to deal with money management, risk management, and psychology.

Any one indicator can really only be part of that overall approach and never fully replace an entire system. Although the Donchian Channel could be a very important part of your Forex trading system, traders should never fully rely on indicators only.

Bad bulish breakout

Image: showing how a bad bullish breakout could be avoided if traders analyzed the higher time frames which showed a resistance zone from a downtrend channel (white lines).

Role of Donchian Channel in a System

In our view, the Donchian channel can play an important role in various parts of a trading system:

  1. As a filter on higher time frames: it is good to avoid trading long right in front of Donchian resistance or short before Donchian support. Always make ensure that there is sufficient space till the next support or resistance level.
  2. As a trigger on middle time frames: the Donchian can confirm a potential trade setup once price confirms a break or a bounce at S&R but it does not need to equal an immediate market entry. This is called a “trigger”. It gives traders a heads-up that an entry is nearby but traders can still look for retracements on lower time frames to get a better entry spot.
  3. As an entry on lower time frames: the Donchian channel can also be used for entries but it is advisable to have more supportive reasons for a trade setup than just the indicator itself. Following indicators blindly will never work out, certainly not in the long run.

Please note that with higher, middle and lower time frames we are referring to a relative level that you use for your trading. The middle time frame is the trend chart, the higher one is used for S&R levels and the lower one for entries. Often we use a daily chart for high, 4-hour chart for a middle and 1-hour chart for entries but another combination could be 4 hour – daily – weekly or 15 min – 1 hour – 4 hours.

Summary

The Donchian Channel indicator is a strong candidate for any trader looking to have automated support and resistance levels on their chart.

The tool offers clear bounce and breakout spots and can be used in various ways, including as an entry, filter, and trigger.

Last but not least, the Donchian Channel becomes even stronger when it’s used as part of an all-around Forex trading system.

About the author

Chris Svorcik

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