Channels are one of the basic tools that are often used to analyze markets, and trading strategies that use channels are very popular in various markets. Channel strategies differ from each other in how the channel is constructed. The Donchian channel strategy is a very simple and interesting channel strategy.
Richard Donchian was one of the legends in the trading world, and he achieved success at a respectable age and continued working until he was very old. Donchian was one of the pioneers of modern trading. He organized Futures Inc., the first futures fund in 1949, and this eventually became the prototype of mutual funds in the U.S. He also created a well-known trading system known as Turtles. Donchian developed a so-called sliding channel in the early 1970s, and it was later named Donchian’s channel.
Donchian’s career on Wall Street started in 1930 when he started selling the Security Pilot service to brokerage companies. This service became popular rapidly. Donchian started working as a securities analyst for Hemphill, Noyes and Co in the summer of 1933, while he was still serving as vice president of the family business, the Samuel Rug Company.
Donchian developed various rules of trading operations during those years using the “follow the trend” trade method as a basis. These rules assume that in the long term, commodity prices will move like bull and bear markets. Donchian developed and traded using a system that combined the Guidance to Trading with its weekly rule system that uses moving averages, and the Rules of Trade.
Donchian has written several articles on securities and futures, earning him the informal title of the father of “trading by following the trend”. Various modern systems that follow trends, including the “Turtle Trading System” are based on his work. Donchian was also an innovator that promoted the concept of a diversified approach to commodity exchanges’ operations.
The Institute of Chartered Financial Analysts of the University of Virginia in 1963 awarded a Chartered Financial Analyst degree to Donchian. During Donchian’s career, he was a member of numerous stock exchanges:
- New York Cotton Exchange
- Commodity Exchange
- New York Society of Security Analysts;
- New York Futures Exchange, and professional market associations:
- National Association of Future Trading Advisers;
- American Statistical Association;
- Financial Forum.
The Donchian channel indicator is used to highlight volatility and generates a price range at a specified point in time on the chart based on the minimum and maximum prices of the asset in the previous period. The indicator displays the lower and upper bands. These bands are constructed by using data of the biggest and smallest price value calculations during the previous trading period.
Calculations
The channel is constructed by using the lowest (Low minimum) and the highest (High maximum) prices for the previous n periods. The area between them is then shown on the chart:
DonchianChannel’s Lower Value = LL (n), the lowest of all the Low values within n periods.
DonchianChannel’s Upper Value = HH (n), the highest of all the High values within n periods.
DonchianChannel Middle = (DonchianChannel Lower Value + DonchianChannel Upper Value) / 2
The indicator should be configured in a separate technical analysis window on Olymp Trade’s platform and is done by selecting the indicator in the Indicators form tab:
Donchian recommended that a period of 20 should be used to build the channel. This will result in the indicator analyzing the values of the previous 20 candles for each current candle and calculating the maximum and minimum values that are used to display the lower and upper bounds. It is logical that a period of 20 is recommended, as there are on average 20 working days per month.
The 20 periods is convenient to constructing the Donchian channel, but different timeframes may also be used, such as 18, 24, etc. 55 periods are used for “Turtles”. A general view of the indicator is shown in the image below:
