Richard Donchian was a futures trader, who\’s ascribed with creating the widely accepted Donchian Channel Indicator. Richard Donchian is referred to as the grandfather of trend following.

The Donchian Channel is created by using the greatest high of x length of time, and the lowest low of the same x length of time, then marking the area between those values on the chart.

The Donchian channel is a beneficial indicator for watching the volatility of a stock. If a price is stable the Donchian channel will be fairly skinny. When the price fluctuates a lot the Donchian channel is going to be wider. Its main use, on the other hand, is for providing signals for buy and sell trades. If a stock trades above its highest x day high, then a long trade is made. When it trades below its lowest x day low, then a short position is entered into. They are handy for predicting support and resistance price levels from an objective point of view.

How It\’s Put Into Use

The Donchian Bands are generally used as a breakout indicator, it defines support and resistance and generate entries as price breaks these levels. Because lows and highs normally correlate with support and resistance levels, this indicator is beneficial in objectively identifying support and resistance levels.

Having said that, it may also be used as a reversal signal – entering when price touches a band and reverses its direction. Before utilizing the indicator in this manner, verify the validity of the psychological level by demanding at the least 2 touches at the level. This makes certain that the signal is solid and elevates its dependability.

One other way of trading the Donchian Band is using its middle band. The middle band is the average of the upper and lower band, and can also be employed to judge trend. Entry signals are produced in the following way: When price crosses the middle band from below – buy, and when price crosses from above – sell. It can be a potent signal when trend strength is is verified with other indicators like the MACD and stochastic.

Investing Using Donchian Bands

There are lots of means of decoding and trading the Donchian Bands. The most popular is definitely the breakout:

1. Long Trades – Long trades are entered when price breaks above the 20-period upper Donchian Band. Defensive traders wait for price to close above the Donchian upper band to enter the trade.

2. Short Trades – Short trades are entered when price breaks below the 20-period lower Donchian Band. Risk adverse traders wait for price to close below the Donchian lower band to get into the position.

Another method of using Donchian Bands is employing the middle band as the buy or sell signal line. Entry signals are created in the following way: When price crosses the middle band from below – buy, and when price crosses from above – sell.

Donchian\’s Twenty Investing Guides

Richard Donchian started out his Wall Street career in 1930. Donchian started out writing a technical market letter in 1933, and carried on for many years. In 1934, Donchian put together the following twenty trading tips which are based in human psychology. Human psychology never changes therefore these rules are still relevant today.

1. Beware of acting right away on a prevalent public opinion. Even if correct, it will usually delay the move.

2. From a duration of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.

3. Limit losses and ride profits, regardless of all other rules.

4. Light positions are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves may prevent unprofitable whip-sawing.

5. Hardly ever take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.

6. Judicious use of stop orders is a valuable aid to profitable trading. Stops can often protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less dangerous if used in proper relation to the chart formation.

7. In a market in which upswings are likely to equal or exceed down swings, heavier position really should be taken for the upswings for percentage reasons – a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%

8. In choosing a position, price orders are allowable. In closing a position, use market orders.

9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules.

10. Moves in which rails lead or participate strongly are often more worth following than moves in which rails lag.

11. An analysis of the capitalization of a company, the degree of activity of an issue, and whether an issue is a sluggish truck horse or a spirited race horse is fully as important as a study of statistical reports.

12. A move followed by a sideways range often precedes another move of just about equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be anticipated.

13. Reversal or resistance to a move is likely to be encountered:
A. On hitting levels at which prior to now, the commodity has fluctuated for a considerable length of time within a narrow range
B. On nearing highs or lows

14. Watch for great buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too often.

15. Watch out for crawling along or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.

16. Breaking of minor trend lines counter to the major trend gives essential position taking signals. Positions can be taken or reversed at such places.

17. Triangles of ether slope may mean either accumulation or distribution subject to other concerns although triangles are often broken on the flat side.

18. Watch out for volume climax, particularly after a long move.

19. Don\’t rely on gaps being closed until you can distinguish between breakaway gaps, normal gaps and exhaustion gaps.

20. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, in particular when volume declines on the reversal.

Author Bio: Lance Jepsen is a 12 year technical analyst and entertainer. To find out more about trading with the Donchian Channel indicator check out Donchian Channel

Category: Finances
Keywords: stock trading,tutorial,lesson