Donchian channels is a trend following indicator.
Being a trend following indicator, Donchian channels was created by Richard Donchian with the main objective of helping traders identify the volatility of the market thus knowing whether the market has gained support or resistance. Donchian channels is considered to be much more the same to bollinger band to the fact that it also has 3 bands,the upper band, the lower band and the middle band.The upper band represents the highest high price over a given n period while the lower band represents the lowest low price over a given n period.The middle band represents the average of the upper and lower band and is used to identify the price breakout.
According to Richard Donchian, the values of Donchian channels is derived using the formula as follows;
middle band=(upper band + lower band)/2
upper band= highest high over a given n period
lower band = lowest low over a given n period
Since donchian channel is a trend following indicator and it has 3 bands, upper band, middle band and lower band, it therefore follows that when the price rises above the upper band that will be an indication of an upward market movement thus the trader should be trading in an upward market direction.If the price rises above the highest high of the upper band, the trader should close any long position since that will be an indication of a resistance point over there.On the other hand, if the price falls below the lower band that will be an indication of a downward market movement thus the trader should be trading in a downward market direction.If the price falls below the lowest low of the lower band,the trader should close any short position since that will be an indication of a support point over there. This is indicated as from the candle sticks chart below;
From the candle sticks chart above, there are 5 points, point A, B, C, D and E. Point A and E represent the breakout points while point B and C represent upper band and lower band respectively. Point D represent the midlle band which is used to indicate occurrence of breakout points.
Initially, at point A the price falls below the lowest low of the lower band thus indicating a support point at that point thus signaling the trader to exit any sell position . Later on, the price rises above the upper band thus signaling the trader to open a buy position since the market is starting an upward trend.
On the other hand, at point E, the price had initially risen above highest high of the upper band thus indicating a resistance point at that point thus signaling the trader to exit any buy position. Later on, the price falls below the lower band thus signaling the trader to open a sell position since the market is starting a downward trend.
Recommendation:If you are a day trader just use 1 min, 5 min, 15 min and 30 min timeframe while if you are a swing trader just use 1 hour and above timeframe if you want donchian channels indicator to work well for you.
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