Donchian Channel Indicator
MT4 Channel TradingFree DownloadThe Donchian Channel Indicator for MT4 is a popular trend-following gauge. It was originally developed by a trading legend and one of the pioneers of technical analysis, Mr. Richard Donchian. This classic indicator is considered as one the most accurate channels on the market. It helps in determining price volatility as well as potential breakouts.
On the first glance it may look a bit plain and simple, but it does a really good job at highlighting trends and providing entry end exit points. This in an example chart in action.
Formula of the donchian channel
It just takes defined number of periods (let’s mark it as N) and using special algorithm it performs calculations, where:
- the upper band is is the highest price for the last N period
- the lower band is is the lower price for the last N period
Simple as that. Please note that the default period set in MetaTrader 4 is 20. You can customize it with no issues in the settings tab.
What kind of insights does it provide?
While it’s not super sophisticated in terms of visual aspects, it surprisingly covers quite a few elements of market’s picture.
Measuring volatility
The area between both channel bands correponds to volatility and it adjusts in real-time. When it’s getting wider it means there are increased dynamics and you can expect significant price fluctuactions. On the other hand, when that area is tight it signifies consolidation phase and you can expect impulse and breakout soon.
Plotting support and resistance levels
The upper and lower lines can also act as support and resistance. They are highest and lowest points in given period. This approach should be further confirmed with some candlestick patterns to confirm the validity of S&R.
Detecting breakouts
This was one of the original concepts and base way of trading with the Donchnian channels. When price firmly appraches one of the lines and the channel expands, there is assumptin that momentum will further continue in that direction and traders should capitilize on that setup.
Trading signals
So the strategy is based on price breakouts that are considered as a start of new trends. The Donchian channel indicator provides pretty decent entry points, but also additional re-entry points during pullbacks. Let’s have a bearish scenario as an example.
The candlesticks should push the lower band to a degree where it also points to the bottom. The idea is to jump in a trend in it’s early stage. What’s more, it’s possible to increase the position during retracements.
For the stop loss, you can place it a few pips away from the opposite band. For take profit target you can use some risk-to-reward ration or even ride it till the arrivial of opposite signal.
See this EUR/USD chart below.
Obviously, for the bullish setup the very same rules are apply, just use the opposite triggers.
Potential combinations
There is no tool with 100% accurate signals, so let’s be reasonable and account fakeouts on occasions. However, there are some indicators combinations to increase the success rate and reduce number of bad signals.
Relative Strenght Index
During breakouts there is often situation that oscillator line of RSI is in extremely oversold or overbought area. It’s wise to avoid such entry, because there is high-probability of pullbuck so better utilize that one.
Moving Average
Moving averages tell us the overall trend of security. The idea is to avoid counter-trend trading and just open trades in the direction of dominant trend. Take a look at this 100-period EMA on EUR/JPY chart.
Fun fact
Did you know that in 80s there was an trading experiment called Turtle Trading Strategy. The participants heavily used a variation of the Donchian channel and the best Turtle Trader generated $30 milion in profits from just $2 million of starting balance. What’s even more impressing, it was achieved in period of just few weeks!
Conclusion
It’s one of these iconic forex indicators with interesting historical background. It could be equipped within standard MetaTrader 4 library with no questions asked. The nowadays performance of the Donchan channel it’s good, but varies depending on the conditions. Of course just like any other tool it’s not perfect and there may be fakeouts from time to time.
