Donchian channels

Donchian channels are made up of three lines: a moving average​​ in the centre, an upper band and a lower band. The upper band measures the highest rise of an asset’s price, the lower band measures the lowest that the price drops to, and the moving average line represents the median or average price that an asset fluctuates between. This is based on a timeframe that can range from just a few minutes to a few months. Therefore, traders can rely on Donchian channels for both short-term and long-term measurement of trends.

The Donchian indicator aims to find relationships between the current and past price of an asset, to show whether there are bullish or bearish​​ trends within a specific time period. The upper band represents the highest price an asset achieved, which is an indication of bullish energy, whereas the lower band represents the lowest price an asset achieved within tougher bearish reversals.

It is possible to calculate all three lines of the Donchian channels by using these simple formulas below. In this instance, ‘N’ represents the timeframe that the Donchian channel is calculated for, whether this be the number of minutes, hours, days or months. Traders often use 20 days as a benchmark for channel calculations.

Upper channel = highest high in previous N periods

Lower channel = lowest low in previous N periods

Middle line = ((upper channel – lower channel) ÷ 2)

Our online trading platform​​ calculates these formulas automatically when you open a position and apply the Donchian indicator to your chart. Therefore, it is not necessary to memorise these calculations, but it is a good idea to have a general understanding of how they work.

Donchian channels produce trading signals after measuring the momentum of a trending market. The indicator helps traders to realise when there is a breakout within the market so that they can ride the trend for as long as possible, until the trend starts to fade. If an asset’s price is trading smoothly around the SMA line and does not cross into either channel, this may indicate that the market is less volatile and there is no clear bearish or bullish trend. However, if the instrument deviates from the moving average line, this can go in two directions:

As we have discussed above, the divergence of price between channels helps traders to choose whether to open a long or short position. They can also use a breakout strategy to determine whether to close their positions. For example, after opening a long position to trade on an uptrend​, the price of a security may continue rising until it hits the upper band. If it manages to break through even further, many traders may choose to keep their long positions open in order to ride the bullish trend.

However, if it hits the upper band but does not manage to break through, this is known as a breakout. If traders are uncertain that the bullish trend will continue and instead predict a bearish reversal coming, they may decide to close their positions and short sell as the assets starts to decline in price. Sell signals are particularly common within the share market, as stock prices are known to be very volatile and can rise and drop at extremes. Learn more about how to short a stock​ here, which is one of the most popular trading strategies​ for this market.

As well as the stock market, Donchian channels are often used within forex trading​, along with other popular trend indicators, such as Bollinger Bands and Keltner channels. This is because the value of currency pairs fluctuate often, introducing short-term price trends, as well as long-term trends of established ‘safe haven’ currencies. A popular trading strategy to use with Donchian channels is day trading​, where it is possible to take advantage of currency price movements, also known as pips, in order to make small but frequent profits. The Donchian indicator helps to identify when a currency pair closes above or below the bands, signalling the trader to liquidate their current position and switch to a long or short, depending on where it has closed.

Traders are able to display breakouts, trendlines and reversal trading strategies through our online trading platform, Next Generation. Our award-winning platform* comes with a wide range of technical indicators, including Donchian channels, that you can customise to suit your trading personality and visual preferences. We also have multiple chart types for display, as well as drawing tools, pattern recognition software and a fully-integrated mobile app for traders on-the-go. Read more about our technical charting features here.