Many experienced traders who use trend indicators in their work give preference to an instrument called Donchian Channel. Thanks to this indicator, you can get information about the situation in the financial market and use buy or sell signals. At first glance, this tool may seem complicated, but it’s worth it to understand the features of its work, and to put it into practice will be easy and convenient.
Indicator Definition
The Donchian Channel is one of the indicators of volatility. With its help, a price corridor is formed on the work schedule based on the minimum and maximum price indicators for the specified period. The developer of this tool for technical analysis is 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 is ease of use and clear signals to start trading.
What is the tool based on?
Richard Donchian showed interest in the financial market before the time of the Great Depression 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: if we consider the long-term perspective, then the price movements in this case are subordinated to the trend movement. 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 a trend begins with a breakdown of the last extremum of the current trend. It is on the basis of this theory that the indicator is based.
Channel on Chart
To use this technical indicator, you do not have to open a new window - the indicator appears on the work schedule. The tool is presented in the form of two moving lines.
- Top line. It has an indicator corresponding to the price maximum for the indicated period of time.
- Bottom line. It is located at the mark corresponding to the minimum price indicator for the selected period.
Thus, a corridor appears on the chart, within which the price moves.
Indicator setting
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 special directory.
Installation progress for MetaTrader 4. Find the folder of files of the trading terminal at C: \ Program Files. It contains the \ MQL4 \ Indicators directory. A 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 the \ MQL5 \ Indicators \ Examples directory. This is where the downloaded indicator files are sent.
After installation, you can open the trading terminal and use the new tool. Call it along the following path “Insert / Indicators / Custom”. In the drop-down box from the proposed indicators, select the Donchian Channel.
Indicator setting
The established Donchian Channel indicator is convenient to use, since the calculation of indicators is automatic based on the specified parameters. The trader will have to enter only one variable - this is the period. The author of this strategy suggested using indicator 20 as a period. It is these data that are specified in the standard settings.
Such indicators are suitable for trading on daily charts. Thus, the calculation will take into account price movements over 20 bars (or candles).
The longer the period is indicated, the wider will be the corridor created by the indicator. Quite often, experienced traders replace the 20 bar indicator with 18, 22 or 24 (even values with a slight deviation from 20).
Indicator Tips
The basic strategy using the Donchian Channel is quite simple and does not require the installation of additional tools. It is based on the breakdown of the corridor. For its successful application, several important rules should be considered.
- 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 risks.
- It’s more convenient to use candles for work, as the analysis pays attention to the body and shadow of the candle.
Signals to trade
According to the main strategy, the Donchian Channel indicator offers 2 types of signal.
- Breakdown of the upper border of the indicator. When this condition is met, a buy order is opened.
- Breakdown of the lower border. Upon receipt of such a signal, the trader opens a sell deal.
The principle of using the Donchian Channel with an alert is well known to traders who use other types of trend indicators in the analysis. It is important to note the important features of the Donchian Channel.
A breakdown of the indicator border is a situation in which the closing price of the next candlestick is above or below the established border. Violation of the indicator border by the shadow of a candle is not a break through the corridor. Speaking about the shadow of the candle, one more feature should be taken into account. When forming a shadow that tests the upper or lower level, the boundaries of the channel automatically expand. This indicator does not affect the trend.
Advisor settings
There is no unequivocal opinion among traders about what data should be entered in the advisor settings. Many prefer the following option.
- The initial position is divided into 2 orders.
- For the first, use the established take profit.
- The second order is closed after the opposite signal appears.
- Trailing stop is installed 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 was 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 an 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, a group of specialists developed another analysis tool based on the Donchian Channel principle. 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, trend directions are much easier to identify.
The only thing you should pay special attention to is the instrument settings. The variable Z must be a number from 1 to 3 inclusive. All other settings should 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 pair.
- Simple settings. The trader needs to specify only one parameter for automatic calculations - the period. In this case, the settings can be left standard.
- The indicator independently eliminates small noise on the chart, so the trader receives already cleaner information. This is achieved only if the timeframe is selected correctly.
- A simple strategy, in which you should take into account only the direction of the trend and observe the penetration of the corridor.
disadvantages
Before using the indicator, the trader should know not only the advantages of the tool and the principle of building a strategy, but also the weaknesses of the tool. This will allow even before the start of work to reduce the risk of deposit discharge. Donchian Channel has several drawbacks.
- Timeframe selection. More accurate data with a minimum number of false breakdowns can be obtained on the daily chart, which makes short-term trading almost impossible.
- The need to use additional tools. Additional indicators should be used to confirm Donchian Channel signals. Otherwise, it is difficult to filter out false data.
- Rollback after breakdown. This fact is not a flaw in itself. It only needs to be considered 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 time frame and additional analysis tools will affect the number of successful transactions. To do this, beginners should follow the chosen strategy and Money Management.