Donchian Channels with Auto Fibonacci Retracement

Apr 22, 2020

Richard Donchian created Donchian Channels, which is a type of moving average indicator and a look-alike of other support and resistance trading indicators like Bollinger Bands.

Donchian Channels has a simple plotting of highest high and lowest low of the last “n” periods.

The “n” periods is based on the trader’s choice, who can select the period according to their requirements ranging from a day, hour and minutes etc.

Traders use Donchian Channels to understand the support and resistance levels.

Donchian Channels is a popular indicator for determining volatility in market prices.

The channels are wider when there are heavy price fluctuations and narrow when prices are relatively flat.

Generally, investors use 20-periods with the Donchian Channels as the default trading setting, but this value can be tweaked based on your trading style.

Donchian channels are mainly used to identify the breakout of a stock or any traded entity enabling traders to take either long or short positions.

Traders can take a long position, if the stock is trading higher than the Donchian channels “n” period and book their profits/short the stock if it is trading below the DC channels “n” period.

The middle band is the average of the upper and lower bands.

The middle band in Donchian channels could also be used as a breakout indicator.

If the stock rises above the middle band of the Donchian channels, then you can open a long position.

On the contrary, if the stock is trading below the middle band of the Donchian channel, then a trader can open a short position.

Combining Donchian Channel trading strategies with other trading strategies might decrease the false entry/exit signals and give a clearer picture of trading opportunities.

If you start to trade a choppy market on an intraday basis, you will be overloaded with false signals.

So, what I noticed is that in order for things to become clearer, we just need to increase the time frame.

Where Donchian Channels Can Fail You

It’s likely not the indicator but more likely our misinterpretation of the signals.

Few areas where the Donchian channel may be tough to read.

Low float stocks are not bound by any indicator, especially Donchian channels.

The challenge with the Donchian channels is that it does not factor in the most recent market volatility.

The indicators provide an equal weighting to all data points.

Therefore when a low float stock picks up and goes on a run, the lower bounds not capture the price movements quickly enough, thus risking giving back more profits than necessary.