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The Donchian Channel is an indicator in chart analysis named after its inventor Richard Davoud Donchian. As such, as the name suggests, it draws a price channel that contains the highest and lowest prices of the last “n” days. The number of days or candles – after all, the indicator can be used in charts of all time levels – is determined by the trader himself.
In Guidants, the indicator can be found under the name HighestHigh/LowestLow and has a default setting of 10 periods (see figure 1).
The Donchian as the Turtles’ basis for success!
The indicator is likely to have become popular primarily through its use in the Turtle Trader program. Two of the most successful traders at the time, Richard Dennis and William Eckhardt, led a discussion in the 1980s about whether traders could be trained or whether they would be “born”. Since no agreement could be reached, they decided to give it a try.
The Turtle Trader project was born, in which less than one percent of over 1,000 people were ultimately selected to be trained as traders. The program used a somewhat modernized interpretation of the Donchian channel and, since both Dennis and Eckhardt and their students were very successful in some cases, the broad investor community also became increasingly interested in the indicator.
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Options and Applications!
Nowadays the indicator is offered in almost every chart program. Besides the possibility to determine the period length, some tools also offer the option to offset the indicator in time. The indicator is also used in other tools, such as Ichimoku.
As already mentioned, the indicator shows the highest high and lowest low of the period length set by the trader. In addition, the width of the channel can also be used to determine the range of fluctuation that has prevailed during this period. In this context, the indicator is also useful as a volatility measure.
In addition to analytical statements on the fluctuation margin or the highest and lowest prices, the Donchian channel can also be used as the basis for a trading system.
The Turtle Traders have finally shown the way. Both entry and exit signals can be derived from the indicator. Breaks out of the channel can be traded, as well as counter-cyclical trading, in which the opposite side is traded after breakouts in order to speculate on a return into the channel or to the other side. This approach became more and more popular after it was discovered that the turtle trader system in its former form hardly made any profits. Appropriately, these contrary approaches became known as Turtle Soup, as one traded contrary to the Turtles and “boiled them down”. Figure 2 almost different approaches together.
The Donchian Channel is a classic instrument of chart analysis and trading. As such it can be used for analytical purposes as well as for direct trading.
With increasing computerisation, however, it has also become apparent that the indicator is no longer as successful as it was in its heyday in the 1980s. As so often, investors should be cautious when following the classic application rules of older indicators. These usually offer only small, often even no advantages at all.