The Donchian Channel indicator is a very simple indicator developed by the famous trader Richard Donchian. The indicator plots two lines – an upper resistance line and a lower support line – which are based on the high and low prices of the last “n” periods. This is pretty simple when compared to some other complicated technical indicators.
In general, the Donchian Channel looks like a combination of moving averages (as it takes the previous “n” periods into account) and Bollinger Bands (which also creates a type of support and resistance with its upper and lower bands).
Calculating the Donchian Channel Indicator
As said before, the Donchian Channel takes the high of the recent “n” periods to draw a resistance line, and the low of the recent “n” periods to draw a support line.
The default setting of “n” is 20, which means that the high and low of the last 20 sessions are taken into account.
In addition, some versions of the indicator also plot a third line which is simply in the middle of the channel and calculated as follows: (last “n” periods’ high + last “n” periods’ low) / 2.
The Donchian Channel can also be used to measure the volatility in the market. Basically, if volatility is low (i.e. recent highs and lows are narrow) the Donchian Channel will plot two narrow lines. On the other hand, if the volatility is high, Donchian Channels will become wider.
Donchian Channel Trading Strategies
The Donchian Channels are the basis of a world-popular trading strategy called “Turtle trading”. In essence, the Turtle trading strategy is based on a breakout of the upper resistance line or lower support line, as shown on the following chart.
As the upper and lower Donchian Channel lines actually represent previous support and resistance lines, a break of those lines generates buy and sell signals. The exit signal is simply a breakout of the channel to the opposite side. This allows to ride the trend for a long period before exiting a trade.
The original Turtle trading strategy used a stop-loss of “two volatility units”, which basically equals to n-period ATR x 2, i.e. two times the average true range of the last 30 periods. This gives enough room for the price to move up and down in order not to be stopped out too early during a strong trend.
You can place your stop-losses according to the Turtle strategy, or simply use the lower support line and place your stop-loss just below the support for a long position, or just below the resistance for a short position.
Here’s another example of the Donchian Channel breakout with a stop-loss level above the upper resistance line and the exit level at the break of the upper channel line.
Notice how the Donchian Channel moves with the recent periods’ highs and lows. We were able to ride the trend until the break of the upper resistance line, which initiated a new uptrend afterwards.
A Simple Yet Effective Strategy
The Donchian Channel is a simple yet very effective indicator because it’s based on support and resistance lines. While some versions of the indicator draw three lines, the most important ones are the upper resistance line based on the high of the last “n” periods and the lower support line based on the low of the recent “n” periods. The default period-setting for the Donchian Channel is 20 periods, but you can change that number to accommodate for the characteristics of the market you’re trading in.