What are Donchian Channels?

Donchian Channels are three lines generated by moving average calculations that comprise an indicator formed by upper and lower bands around a mid-range or median band. The upper band marks the highest price of a security over N periods while the lower band marks the lowest price of a security over N periods. The area between the upper and lower bands represents the Donchian Channel. Career futures trader Richard Donchian developed the indicator in the mid-twentieth century to help him identify trends. He would later be nicknamed "The Father of Trend Following".

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Key Takeaways

  • The indicator seeks to identify bullish and bearish extremes that favor reversals as well as breakouts, breakdowns and emerging trends, higher and lower.
  • The middle band simply computes the average between the highest high over N periods and lowest low over N periods, identifying a median or mean reversion price.

The Formula for Donchian Channels is

Formula

Where:

N = Number of Minutes, Hours, Days, Weeks, Months

Period = Minutes, Hours, Days, Weeks, Months

How To Calculate Donchian Channels

Channel High:

  1. Choose time period (N minutes/hours/days/weeks/months).
  2. Compare the high print for each minute, hour, day, week or month over that period.
  3. Choose the highest print.
  4. Plot the result.

Channel Low:

  1. Choose time period (N minutes/hours/days/weeks/months).
  2. Compare the low print for each minute, hour, day, week or month over that period.
  3. Choose the lowest print.
  4. Plot the result.

Center Channel:

  1. Choose time period (N minutes/hours/days/weeks/months).
  2. Compare high and low prints for each minute, hour, day, week or month over that period.
  3. Subtract the highest high print from lowest low print and divide by 2.
  4. Plot the result.

What Do Donchian Channels Tell You?

Donchian Channels identify comparative relationships between current price and trading ranges over predetermined periods. Three values build a visual map of price over time, similar to Bollinger Bands, indicating the extent of bullishness and bearishness for the chosen period. The top line identifies the extent of bullish energy, highlighting the highest price achieved for the period through the bull-bear conflict. The center line identifies the median or mean reversion price for the period, highlighting the middle ground achieved for the period through the bull-bear conflict. The bottom line identifies the extent of bearish energy, highlighting the lowest price achieved for the period through the bull-bear conflict.

Example of How To Use Donchian Channels

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What are Donchian Channels?

In this example, the Donchian Channel is the shaded area bounded by the upper green line and the lower red line, both of which use 20 days as the band construction (N) periods. As price moves up to its highest point in the last 20 days or more, the price bars “push” the green line higher and as price goes down to its lowest point in 20 days or more, the price bars “push” the red line lower. When price decreases for 20 days from a high, the green line will be horizontal and then start dropping. Conversely, when price rises from a low for 20 days, the red line will be horizontal for 20 days and then start rising.

The Difference Between Donchian Channels and Bollinger Bands

Donchian Channels plot the highest high and lowest low over N periods while Bollinger Bands plot a simple moving average (SMA) for N periods plus/minus the standard deviation of price for N periods X 2. This results in a more balanced calculation that reduces the impact of big high or low prints.

Limitations of Using Donchian Channels

Markets move according to many cycles of activity. An arbitrary or commonly used N period value for Donchian Channels may not reflect current market conditions, generating false signals that can undermine trading and investment performance.