Donchian Channel: Application of the indicator

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Many experienced traders who use trend indicators in their work prefer a tool called the Donchian Channel. Thanks to this indicator, you can get information about the situation on the financial market and use buy or sell signals. At first glance, this tool may seem complicated, but once you understand the features of its work, it will be easy and convenient to use it in practice.

Indicator definition

Donchian Channel is one of the volatility indicators. With its help, a price corridor is formed on the working chart, based on the minimum and maximum price indicators for the specified period. The developer of this tool for technical analysis is considered to be Richard Donchian, who at one time was a very successful trader on Wall Street.

The effectiveness of this tool has been confirmed by numerous tests and practical applications. Its advantage lies in its ease of use and clear signals to start trading.

What the tool is based on

Richard Donchian showed interest in the financial market even before the GreatDepression that erupted in 1929. At that time, many traders lost their capital and became disillusioned with securities transactions. Richard, on the contrary, was eager to find an effective tool for analysis.

He devoted a lot of time to observing and studying the fundamentals of the financial market, and as a result came to the conclusion that if we consider the long-term perspective, then price movements in this case are subject to the movement of the trend. However, these conclusions were only the beginning.

Richard's main merit is to develop a new strategy. Its essence lies in the fact that a change in the direction of the trend begins with the breakdown of the last extremum of the current trend. It is on the basis of this theory that the work of the indicator is based.

Chart channel

To use this technical indicator, you do not have to open a new window - the indicator appears on the working chart. The instrument is represented as two moving lines.

1. Top line. It has an indicator corresponding to the price maximum for the specified period of time.
2. Bottom line. It is located at the mark, which corresponds to the minimum price for the selected period.

Thus, a corridor appears on the chart, inside which the price moves.

Setting the indicator

The Donchian Channel indicator is not included in the standard MT5 and MT4 platform, therefore, to use it, this indicator is freely available and the archived files are downloaded to a computer in a specialdirectory.

Installation progress for "MetaTrader 4". Find the trading terminal files folder at C:\Program Files. It contains the \MQL4\Indicators directory. The folder with the downloaded Donchian Channel indicator is copied to this directory.

Installation progress for "MetaTrader 5". In general, the installation principle does not differ from the previous version, but the name of the directory will be different. First of all, open the C:\Program Files folder located on the computer. The next step is to search for the \MQL5\Indicators\Examples directory. This is where downloaded indicator files are sent.

After installation, you can open the trading terminal and use the new tool. Call it on the following path “Insert/Indicators/Custom”. In the drop-down box, choose Donchian Channel from the suggested indicators.

Indicator settings

The installed Donchian Channel indicator is convenient to use, since the indicators are calculated automatically based on the specified parameters. The trader has to enter only one variable - this is the period. The author of this strategy suggested using the indicator 20 as a period. These data are specified in the standard settings.

Such indicators are suitable for trading on daily charts. Thus, price movements over 20 bars (or candles) will be taken into account in the calculation.

The longer the period is specified, the wider the corridor created by the indicator will be. Quite often, experienced traders replacean indicator of 20 bars on 18, 22 or 24 (even values with a slight deviation from 20).

Tips for using the indicator

The basic strategy using Donchian Channel is quite simple and does not require any additional tools to be installed. It is based on the breakdown of the corridor. For its successful application, several important rules should be taken into account.

1. Experts in the field of trading in the financial market recommend working on a daily chart. This allows you to reduce the number of false signals, and therefore reduce the risks.
2. It is more convenient to use candlesticks for work, as the analysis pays attention to the body and shadow of the candlestick.

Signals to trade

According to the main strategy, the Donchian Channel indicator offers 2 types of signal.

1. Breakout of the upper limit of the indicator. When this condition is met, a buy order is opened.
2. Breakout of the lower border. Upon receipt of such a signal, the trader opens a deal to sell.

The principle of using the Donchian Channel with an alert is well known to traders who use other types of trend indicators in their analysis. At the same time, it is necessary to note the important features of the Donchian Channel.

The breakout of the indicator border is a situation in which the closing price of the next candle is above or below the established border. Violation of the indicator border by a candlestick shadow is not a penetration of the corridor. Speaking about the shadow of a candle, one more feature should be taken into account. When forming a shadow that tests the upperor lower level, the channel boundaries are automatically expanded. This indicator does not affect the trend.

Setting up the Expert Advisor

There is no unequivocal opinion among traders about what data should be entered into the adviser settings. Many people prefer the next option.

• The initial position is divided into 2 orders.
• For the first one, the set take profit is used.
• The second order is closed after the opposite signal appears.
• Trailing stop is set on the opposite border of the corridor.

Compliance with all the above requirements and work on the daily chart can bring the trader 10-20% per annum. However, this strategy has a serious drawback. It consists in the presence of a rollback, which occurs after the penetration of the corridor occurs. This forces traders to wait out the drawdown after an alert has been received from the Donchian Channel indicator.

Additional indicators will help solve this problem, in which the channel will act as a tool to identify a strong trend. In this case, the efficiency will increase when using the oscillator.

Donchian Channel Modifications

Despite the effectiveness of this technical tool, many beginners bypass it. This is explained by errors in trend identification. Many traders are really lost and cannot determine the direction of the existing direction in the financial market.

In order to solve this problem, the groupspecialists has developed another analysis tool that works on the principle of the Donchian Channel. This indicator is called NeuroTrend. On the chart, it differs little from its predecessor, but it has one feature - the division of the price corridor into blocks. With their help, it is much easier to identify the direction of the trend.

The only thing you should pay special attention to is the tool settings. The variable Z must be a number between 1 and 3 inclusive. All other settings must be 0.

Benefits of using the indicator

The high popularity of this technical tool provides several advantages of use.

• Ability to apply on any chart. The Donchian channel is equally effective on any currency pairs.
• Easy settings. The trader needs to specify only one parameter for automatic calculations - the period. In this case, the settings can be left as standard.
• The indicator automatically eliminates small noise on the chart, so the trader receives more pure information. This is achieved only if the timeframe is chosen correctly.
• A simple strategy in which you should consider only the direction of the trend and watch the corridor break through.

Flaws

Before using the indicator, a trader should know not only the advantages of the instrument and the principle of building a strategy, but also the weaknesses of the instrument. This will reduce the risk of deposit drain even before the start of work. AtDonchian's channel is highlighted by several shortcomings.

1. Timeframe selection. More accurate data with fewer false breakouts can be obtained on the daily chart, making short-term trading almost impossible.
2. The need to use additional tools. Additional indicators should be used to confirm Donchian Channel signals. Otherwise, it is difficult to weed out false data.
3. Retracement after breakout. This fact is not a disadvantage in itself. It just needs to be taken into account when building a strategy.

In other words, the Donchian Price Channel can be called a strategy with relatively high efficiency. At the same time, the correct choice of timeframe and additional analysis tools will affect the number of successful transactions. To do this, beginners should follow the chosen strategy and Money Management.